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Yellen or Kohn? Tapering or Not? Wednesday's Results Are Key to Indices' Future


Some form of tapering will probably begin tomorrow and Yellen will likely be made Fed chief.

So, it looks like it may be "Yellen with a side of tapering." How will the markets react? Unfortunately, there's little edge to be had going into Wednesday's fun.

Will President Obama's disdain for the 1% outweigh his political needs?

Before I get into this week's analysis of the bond and currency markets, I wanted to think out loud (in writing) on a couple of Fed-related questions leading up to tomorrow's follies.

First, is Janet Yellen really the next choice as Ben Bernanke's replacement? The word on the street is that Obama would not be that enthusiastic about the Yellen nomination because he doesn't want to be seen as settling for his second choice. The other candidate mentioned by Obama recently is Donald Kohn, who was Bernanke's right-hand man during the financial crisis as well as Chairman Greenspan's second for many years. While Yellen is a noted dove, Kohn is certainly more of a cautious dove -- if not an outright hawk. Additionally, Kohn would likely be an easier nominee to get through the confirmation process as he was a George W. Bush appointee, whereas Yellen was appointed by Obama.

The second question is whether this news -- even if Yellen is the pick -- will alter the Fed's tapering plans. If tapering begins as expected in the days / weeks / months ahead with Helicopter Ben at the wheel, are we to expect that Yellen will pull tapering off the table? Probably not. However, it will mean that if things get dicey in the risk markets, there will likely be a "Yellen put" acting as a safety net supporting the market.

Another way of looking at the choice of Yellen over Kohn, should it happen, is that the Tepper Trade (made famous by David Tepper of Appaloosa Management) will probably remain "on." That is where risk assets rally on bad news because the Fed is there as a backstop, and they rally on good news because things are getting better. Either way, risk assets rally.

It is definitely fair to say that if Donald Kohn's name is called instead of Yellen's, this euphoric rally in risk assets (stock futures, the euro, the Aussie dollar, and Canadian Dollar just to name a few) will reverse course rather quickly. But, with elections coming up next year, will Obama do anything to upset the rally in stocks? Deep down he probably hates the idea of stocks rallying while the US economy struggles to get out of first gear. But, he is a skilled politician and would likely hate even worse losing the edge in Congress due to the stock market tumbling because of choice of an appointee – so I'm leaning toward a Yellen pick by Obama (but I wouldn't necessarily be betting on it).

To taper or not to taper – that is the question (at least for Wednesday).

As I noted in last week's article, I feel the odds favor a token tapering announcement just to appease the hawks on the FOMC – a.k.a. "tapering in name only." If we analyze the three possible announcements the FOMC could make tomorrow regarding tapering, there appears to be three clear and distinct paths the risk markets could take:
  • Full speed tapering -- which seems rather unlikely -- would almost certainly cause a good portion of the "risk-on" trade to be taken off the table.
  • Partial tapering -- which seems to be what the markets are pricing in currently -- would likely cause minimal market reaction at this point.
  • And finally, if a full delay of the tapering program is announced Wednesday, it would certainly be a surprise to most market participants and would most likely trigger a major short-covering rally.
What do the charts tells us about Wednesday's likely outcomes?

Bond yields could really go either way here.

The yield on the 10-year Treasury Note is just above a possible "correction resistance" level which, if it holds, could serve as a springboard for another shot higher in yields to the 3.019% area. If support fails, though, the net stop on the downside for yields will be the 2.46% - 2.66% range. There's no real edge for either side here going into Wednesday, in my honest opinion.

Click to enlarge

DXY hovering dangerously just above key support at 81.01.

The DXY has been under pressure ever since Sunday night and the breaking of the Larry Summers news. However, it has managed to hold up above possible "correction support" at 81.01 thus far. Again, under normal circumstances this might be a good low risk / high reward entry on the DXY. But, the probability of a large gap in either direction off of tomorrow's news makes this a poor reward / risk trade as well.

Click to enlarge

Gold trades bearishly still – possibly giving the edge to "tapering."

The one chart that tells me that there's a better chance of at least some tapering starting tomorrow is that of gold futures. The chart is clearly bearish and at best points to a modest bounce prior to more downside. That almost certainly does not occur in a falling rates environment, so… draw your own conclusions there.

Click to enlarge

Overall, I'm sticking with my call for some tapering to start tomorrow / this month. In terms of Bernanke's replacement, I – like many prognosticators – am leaning toward Yellen.

(See also: If the Fed Doesn't Taper, What Happens to Gold, Stocks, Real Estate, Treasuries? and 3 Things Investors Should Consider When Playing the Fed This Week.)

Twitter: @seachangereport

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