All eyes today will be on the 2021 Jackson Hole Economic Policy Symposium, the annual gathering of about 45 of the world’s central bank heads organised by the Kansas City Federal Reserve. The decision to hold the event virtually, for the second year running, was only taken ten days ago as a result of concerns over the spread of the more virulent Delta strain of the Covid-19 virus. The impact of the Delta strain on the US and global economy and importantly central banks’ monetary policies will undoubtedly be a central theme of this year’s “Macroeconomic Policy in an Uneven Economy” Symposium.
Opening remarks by Federal Reserve Chairperson Jerome Powell scheduled for 15:00 (London time), will be streamed live here and will undoubtedly be the highlight of a packed agenda. However, the importance of sideline remarks by other major central bank leaders should not be under-estimated, particularly as the landscape for monetary policy in major economies is very granular and the outlook still uncertain.
We would also importantly flag that prior to Powell’s speech the Bureau of Economic Analysis will release at 13:30 key US personal income, spending and Personal Consumption Expenditure (PCE) inflation data for July. Markets are likely to focus on core PCE-inflation figures, which strip out more volatile food and energy prices, given that the latter is the Federal Reserve’s preferred measure of inflation.
One over-riding question: Will Powell detail Fed’s tapering plans for its asset-purchases
The Jackson Hole Symposium has since the 2008 financial crisis and the 2013 “taper tantrum” acquired even greater importance in the eyes of investors, analysts and policy-makers across the world. The financial market community will dissect every word of Powell’s opening remarks with surgical precision. But ultimately there is one question on everybody’s lips: will Powell announce when and how the Federal Reserve plans to start tapering its QE program and what are the likely implications for FX, rates and equity markets. Specifically markets have for months now been eager (desperate?) to know when and how quickly the Fed plans to start reducing its monthly purchases of Treasuries and agency mortgage‑backed securities currently running at respectively $80bn and $40bn.
It’s a simple enough question but whether the answer is clear-cut is open for debate given the current US and global macro-economic juncture. In a nutshell US indicators of consumer price inflation remain at elevated levels but there is also clear evidence that US and global economic growth has slowed in the past month. Powell knows that his every word will matter and that he will be walking a fine line – he will want to reassure markets of the Fed’s inflation-targeting credentials while avoiding setting in motion events which destabilise financial markets and further depress US and global economic growth.
Which of these two priorities is the most important to Powell and the Fed is akin to asking a parent which of its two children it prefers. After all the Fed has an official dual mandate of fostering economic conditions that achieve both stable prices and maximum sustainable employment. However, we would venture that the Fed will for now attach slightly greater weight to further shoring up consumer and corporate confidence and the US labour market and ultimately putting a floor under US economic growth.
Past month has complicated macro and policy picture for Powell and the Fed
The Fed minutes of its 28th July policy meeting (released on 19th August) revealed that most FOMC members thought that it could be appropriate for the central bank to start tapering its monthly asset purchases in Q4. However, since then US macro data have been mixed and global economic growth has arguably slowed and a number of the more hawkish FOMC members have slightly rowed back from that more “hawkish” view. Powell could well echo a more neutral view today.
#1. Consumer price inflation
The Fed has in recent months consistently stuck to its view that the spike in US measures of consumer price inflation will be “transitory”, with its tolerance to high rates of inflation underpinned by its average inflation targeting model unveiled at last year’s Jackson Hole Symposium[1]. US CPI-inflation data for July, released on 11th August, arguably gave the Fed some breathing space, with core CPI-inflation falling to 4.3% yoy from 4.5% yoy in June and headline CPI-inflation remaining unchanged at 5.4% yoy (see Figure 1). If the arguably more important PCE-inflation data for July, due for release this afternoon, exhibit a similar trend as CPI-inflation, this would at the margin arguably shore up the Fed’s “transitory” narrative.
Figure 1: Year-on-year core CPI-inflation fell in July but did core PCE-inflation follow same trajectory?
[1] Specifically, Powell announced on 27th August 2020 that going forward the Fed would “seek to achieve inflation that averages 2% over time” and therefore that “following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.” He specified that the “Fed was not tying itself to a particular mathematical formula that defines the average”.
#2. Employment
Underlying this new Fed inflation-targeting stance was a subtle but greater emphasis on full employment. Indeed at its 28th July policy meeting the Fed concluded that since December the economy had made progress towards toward its maximum employment and price stability goals but that the US economy was some way away from having had substantial further progress toward the maximum employment goal. Data released on 6th August revealed that the US economy had created a further 943,000jobs in July (the highest monthly print since August 2020).
While the US economy has created an impressive 4.3 million jobs year-to-date, total employment (excluding farming) remains 5.7 million short of its pre-pandemic level of 152.5 million in February 2020 (see Figure 2). Employment in the private-sector is still 4.9 million short of its pre-pandemic level. Whether this constitutes substantial further progress toward the Federal Reserve’s maximum employment goal remains the million Dollar question, particularly as the Federal Reserve will be looking at a very wide-range of labour market and macro-economic indicators (at the risk of stating the obvious).
Figure 2: Recovery in US labour market has been impressive but has it been “substantial”?
#3. Other macro data
More broadly the US macroeconomic picture has been mixed. The consensus view is seemingly that that US economic growth, which accelerated to a seasonally-adjusted annualised rate of 6.6% quarter-on-quarter in Q2, remained solid in July but slowed in August.
- Retail sales: The USD-value of retail sales contracted 1.1% mom in July but from very high levels, with retail sales in May-July still 20% higher than in the corresponding period of 2019 (see Figure 3). There has been some “catch-up” spending as the US economy has re-opened but these are still potent numbers. The US consumer is still doing what it does best: spending.
- ISM non-manufacturing PMI: This timely index of economic activity in the key US service sector rose to 64.1 in July – the highest print since comparable records began in 1997 – from 60.1 in June.
- ISM Manufacturing PMI: This index of economic activity in the US manufacturing sector fell to 59.5 in July, a 6-month low, from 60.6 in June.
Figure 3: Much was made of month-on-month fall in US retail sales in July…but it was from very high levels
#4. US equities
Cynics argue that the Fed will continue to pump-prime the US economy, via quantitative-easing and low policy rates, partly in order to fuel US equity markets. The Fed would of course strongly refute such allegations (after all stock market prices are not a Fed target) but neither will it be oblivious to the fact that the S&P 500 is just 0.6% off the record-high recorded on 25th August.
After all there is compelling evidence, in our view, of a strong, positive historical correlation between US disposable income (including wages & salaries), US consumer confidence, households’ net-worth (including equity holdings), and PCE inflation (see The key quartet: US income, confidence, net worth and consumption, 18th September 2019). The Fed certainly does not (and never had) a target level for US equity indices but Powell will be acutely aware of the (negative) implications for the broader economy should US equities tank because of a “misjudged” Jackson Hole speech, in our view.
Global economic growth has likely slowed in recent months albeit from very high levels
Global economic growth has most likely slowed since peaking in May, and particularly in the past month or so, partly as a result of governments in Asia Pacific re-introducing local and/or country-wide lockdowns and social distancing restrictions (including in China, Japan, Australia, New Zealand and Vietnam). They have responded to rising cases of the more virulent Delta strain of Covid-19 in the context of still low vaccination rates and concerns about the long-term efficacy of vaccines. Chronic global and supply-chain constraints and bottlenecks, labour shortages in developed economies and still cautious consumers have further weighed on global output and demand.
Historically quarter-on-quarter global GDP growth has correlated closely with the quarterly change in the Global Composite PMI (see Figure 4).
Figure 4: Global GDP growth almost doubled in Q2 to 01.5% qoq, thanks in part to re-opening of economies…
Note: * The Global Composite Output Index, commonly referred to as the Global Composite PMI, is a weighted average of the Global Manufacturing Output Index (which accounts for 25% of the Global Manufacturing PMI) and the Global Services Business Activity Index (one of the eight components of the Services Index).
Based on this relationship, the fall in the Global Composite PMI to a 4-month low of 55.7 in July from 57.1 in Q2 suggests that global GDP growth, which had almost doubled to 1.5% qoq in Q2, remained positive but slowed further in July (see Figure 5).
Figure 5: … but signs that rate of economic growth may have slowed since May albeit from very high level
Markets has shunned traditional “risk-on”, “risk-off” stance ahead of Powell speech
Looking at financial market price action in the past few weeks, we would draw two conclusions. First that the Fed will not be too dissatisfied (both in terms of levels and volatility) and second that markets have not taken a particularly strong view about what Powell will say (or not say) today and the implications for major currencies (including the Dollar) and interest rate markets.
The appreciation in the “safe-haven” Dollar has been slow and “orderly” and in the past three months broadly mirrored the gradual steepening of the 2s-10s Treasury yield curve (see Figure 6). We note that the Dollar NEER has been stuck in a narrow range of just 0.8% in the past nine sessions, according to our estimates.
Figure 6: Dollar’s appreciation has been slow and orderly and mirrored steepening of US Treasury yield curve
Note: 10-year yield minus 2-year yield
Volatility in the Dollar Nominal Effective Exchange Rate (NEER) also remains very subdued (see Figure 7).
Figure 7: S&P 500 has seen ebbs & flows in recent weeks, oil price very choppy but Dollar volatility subdued
US 2-year Treasury yields are currently trading at about 0.24%, well within the range of about 0.16-0.28% in place since the Fed’s 16th June policy meeting. Similarly 10 and 30-year yields have been range-bound since early July. Moreover volatility in US Treasury yields has gradually fallen since mid-June (see Figure 8), a sign in our view that markets have gradually found their feet (at least for now).
Figure 8: Volatility in US Treasury yields has fallen across the maturity curve
Finally, the relative performance of major currency blocks does not clearly point to either “risk-on” or “risk-off” having prevailed, in our view. So far in August, a weighted-basket of Emerging Market (EM) currencies (excluding the Chinese Renminbi) has depreciated 0.5% versus the Dollar, according to our calculations, while a GDP-weighted basket of developed market currencies has weakened about 0.9% (see Figure 9). So no clear distinction performance between “risky” and “less-risky” currencies. Within EM currencies, high-yielding currencies (-0.4%) have slightly outperformed low-yielding currencies (-0.7%), which at the margin would typically point to a “risk-on” environment. Nevertheless that is a harder case to make when the supposedly “safe-haven” Dollar has appreciated 1% over that time period.
Figure 9: Dollar and S&P both up, EM and developed currencies level-pegging = neither “risk on” or “risk off”
Note: * USD NEER is US Dollar Nominal Effective Exchange Rate (Federal Reserve trade weights).
Powell will want to retain some temporal flexibility
Powell will not want to unnecessarily rock this reasonably stable boat, in our view. He could today flesh out the timeline for the Fed’s announcement of when it will actually start to reduce its monthly asset purchases or at least further refine the Fed’s view on what US macro conditions need to be met in order for the Fed to be more clear-cut about the future modalities of its QE program.
However, we think it is unlikely that Powell will today tie the Fed to a hard-baked timeline and we stick to our core scenario that the Federal Reserve will only start tapering its monthly asset purchases in early 2022 (or late-2021 at the earliest) and only start hiking its policy rate in 2023. However, we also think that that the gap between the start of the taper and the start of the rate hiking cycle will likely be materially shorter than the 24 months gap in 2013-2015.
The bottom line is that while even incremental tweaks in Fed policy can have significant and long-lasting implications for financial markets, US monetary policy will remain very loose (by any metric) for many months to come. Other major central banks will carve their own paths but, like the Fed, they too may near term put greater emphasis on current economic growth jitters than on sticky and/or high CPI-inflation.
