As we advanced last week, The Jackson Hole meeting was taking place between the 25th and the 27th of August. In our last week’s article with the commentaries of the potential outcomes we could see an interest from the asset management professionals about the intentions on the FED intentions to control inflation and rate hikes, now we have received the first comments after the meeting.
Mark Nash, Investment Manager, Fixed Income – Absolute Return
Jerome Powell’s Jackson Hole speech was purposely short to deliver a direct unquestioning message to the markets. After July’s CPI downward surprise there is no victory dancing at the Fed yet, far from it, just dogged determination to get inflation down to 2%. His omission of risks to the growth outlook added weight to this focus. His marathon speech at Jackson Hole last year likely contributed to this decision when, back then, he set out all the reasons inflation should be transitory, and the Fed had the luxury to support growth. His tone surprised the market which had been increasingly looking for a Fed pivot to lower interest rates as soon as next year.
The euphoria over getting headline inflation down as commodity prices have fallen and supply chains have improved had contributed to this dovish take by the market going into the speech. However, this alone will not be enough to get inflation down to the Fed’s target, as domestically driven inflation from services and shelter due to a tight labour market remains a huge problem. In addition, economic data has started to re-accelerate with the fall in gasoline price spurring a rise in real incomes reigniting market expectations of higher inflation in the future.
Powell rightly focused on the tight labour market and he backed recent Fed speeches that the cuts priced into 2023 and 2024 are not justified. This is a Fed that will get rates up and keep them there reacting asymmetrically to economic developments by keeping more tightening on the table but not taking the risk of cutting any time soon. Powell used the 1970s example when the Fed chased their own tail, cutting prematurely on economic weakness which led to inflation oscillating out of control as the economy went through a boom and bust cycle. Things are different to today, but there are some similarities as labour and capital become less globally mobile.
The market easing in US financial conditions as bonds and equities rallied in recent months looks unjustified. There’s little question that the Fed is going to be tough and so the outcome for markets now hinges on whether it will be a soft or hard landing to get the necessary fall in inflation. The former requires labour supply to return and job openings to fall without causing too many job losses to help wage gains ease back. If wages stay high, the latter will require much higher yields and lower equities to create more recessionary conditions. The message was received loud and clear by the markets as equities fell sharply and bond yields rose.
Tiffany Wilding, North American Economist, and Allison Boxer, Economist, at PIMCO
Market participants listened closely to Federal Reserve officials at the annual symposium in Jackson Hole, Wyoming, for any sign of how committed the central bank remains to fight inflation amid concerns about the associated costs to growth and employment. Chair Jerome Powell’s message in Friday morning’s speech was short, clear, and direct: Inflation remains too high, and the Fed will not back down from doing what it takes to bring inflation under control. Having learned from history, Fed officials warned that they would not be quick to declare victory on inflation. This means investors, businesses, and communities should expect higher interest rates for longer as policymakers commit to sustainably bringing inflation down. With inflation projected to moderate to a still above-target pace, we believe the Fed will deliver additional outsize tightening this year and then keep rates on hold even as the U.S. economy slows into 2023.
Short and to the point
Chair Powell’s much-anticipated speech delivered the hawkish message market participants were looking for. In one of the shortest Jackson Hole speeches by a Fed chair in recent memory, he unequivocally reaffirmed the Fed’s commitment to bringing inflation down even though it is likely to require “some pain.” Chair Powell turned to lessons from history to underscore how today’s Fed officials recognize that they cannot afford to let inflation expectations become unanchored, and that rates will continue to constrain demand until officials are sure that inflation is fully back under control.
Chair Powell’s comments were echoed by other Fed officials in many media interviews occurring alongside the symposium. Despite more muted inflation reports in July across both CPI (Consumer Price Index) and PCE (Personal Consumption Expenditures), Fed officials are not close to being ready to declare victory on inflation. This is consistent with our view that though there are signs of U.S. inflation being at or near a peak on a year-over-year basis, the underlying trend of inflation looks inconsistent with the Fed’s target. Officials were careful to emphasize data dependence and shied away from providing guidance for the next Fed meeting. Instead, they emphasized that market participants should not expect rate cuts – the Fed’s usual reaction to a period of slower growth – to happen anytime soon. The Fed’s communication strategy seems to be allowing flexibility to react to upcoming data in sizing the rate hikes for the remainder of this year, while at the same time tightening financial conditions by pushing back on markets pricing in a quick pace of rate cuts next year.
The symposium in Jackson Hole brought together academics and policymakers to consider the broader lessons from the supply constraints that have been a hallmark of the pandemic period. While Fed officials may be taking each individual data point in turn as they consider the near-term path for policy, these considerations have important implications for monetary policy in the medium and long term. Sessions explored how the pandemic period may affect longer-run productivity, output, and neutral policy rates – raising questions about whether the Fed’s framework needs to evolve to address these new challenges.
More tightening to come
The outlook for higher inflation and lower growth has put the Fed in a tough spot, but the central bankers used Jackson Hole to reaffirm that their key focus remains anchoring inflation expectations by rapidly raising the fed funds rate. This approach has already produced the fastest pace of financial conditions tightening since the 2008 Lehman Brothers bankruptcy, according to PIMCO’s U.S. Financial Conditions Index. Over the next few quarters, we expect Fed officials to continue along the path of monetary policy tightening previously laid out, and the messages relayed at Jackson Hole reaffirmed that tighter monetary policy is here to stay despite the challenging outlook for growth.
Gilles Moëc, Chief Economist at AXA
There was no significant surprise in Jay Powell’s short speech in Jackson Hole. For all the hope in the market for a “dovish pivot” (more on this later), we agreed with most commentators’ expectations of a Fed willing to “toe the line” on the continuation of tightening. Powell made it clear that the FOMC will need to see a confirmed downward trend in inflation before pausing, especially given the level at which policy rates are now. The current Fed Funds are in the neutral range, and they will need to be pushed to restrictive territory. Two sentences summarize these points: “The lower inflation readings for July are welcome, a single month’s improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down” … “with inflation running far above 2 % and the labor market extremely tight, estimates of longer-run neutral are not a place to stop or pause”
In the short run, what the market was really focusing on is the speed and extent of this move into restrictive territory. Powell did not say anything clear on this front. Our best attempt at an interpretation of his words is that another 75-bps hike is possible in September, but it is not a done deal since it is clearly data dependent. The Fed boss was very explicit about the very next data prints being crucial for them to make their decision between 50 and 75. If they go for 75 next month, it would probably be the last time, but even that is not carved in stone: “Our decision at the September meeting will depend on the totality of the incoming data and the evolving outlook. At some point, as the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases”. The general direction of travel is clear, but forward guidance is not what it used to be ….
What strikes us in the current policy debate is the twin interrogation on (i) the underlying message from the recent dataflow and (ii) the 1970s “high inflation” precedent – which figured prominently both in Powell’s speech and in the more academic discussions in Jackson Hole. On the first issue, it’s increasingly clear that it’s the signal from the US labor market which will determine the central bank’s trajectory. On the second, it seems that a topical take-away from the “Burns and Volcker times” for the current conversation may be the interaction between monetary and fiscal policy. We want to devote the bulk of this Macrocast on these two issues.
Laurent Benaroche, Fund Manager Multi Asset & Overlay at Edmond de Rothschild Asset Management
Double-digit inflation is becoming widespread, labour markets are robust, financial conditions are improving despite monetary tightening, and economic data are slowly declining although advanced indicators are tumbling. As a result, central bank heads at the Jackson Hole symposium reaffirmed their determination to smash inflation and opt for higher rates over a longer period.
Even if this means a recession, it is an absolute priority for the FED and the ECB and it explains why equity markets have been tumbling since.
Thomas Hempell, Head of Macro & Market Research at Generali Investments Partners
What a difference a year makes. At last year’s Jackson Hole meeting, Fed Chair Powell pledged to seek max. employment and dismissed inflation as transitory. This year, central bankers hammered down their unconditional commitment to tame inflation –and prepared for looming pain in this fight. Price pressures persist amid rising wages in the US and soaring energy costs in Europe.
The 1970s teach that central banks (CBs) need to act early and forcefully to prevent rising inflation expectations from perpetuating price pressure. So even amid rising recession risks, Powell prepared Americans for “some pain” (weaker economy and less jobs), while ECB’s Schnabel predicted a larger “sacrifice” to tame price pressures than in previous tightening periods. For September, this implies that 50 bps hikes seem to be the minimum for both the ECB (Sept 8) and Fed (Sept 21) –with even 75 bps steps to be considered.
Rate moves impact the real economy with a substantial lag, bearing the risk of overtightening. The imminent economic downturn, easing supply chain pressures and softer commodity prices may still allow CBs to tune down their tightening pace in autumn. The steep repricing of rate expectations (now pricing +135 bps hikes for the Fed by YE, +155 bps for the ECB) has already gone pretty far. But given CBs’ firm pledge to maintain their current hawkish posture, a quick reversal in expectations seems little likely.
Jason England, Gestor de Carteras de Renta Fija Global en Janus Henderson
Last year at the annual Jackson Hole Symposium as the hawks grew louder and increased in number around tapering, we suggested ignoring them and focusing on what Chair Powell had to say at the event. This year the Federal Reserve has become more aligned on what is necessary to fight historically high inflation with even the most dovish members becoming hawks.
Chair Powell shared the same hawkish tone as other Fed speakers we heard at the event even if the tightening will bring some pain to households and businesses. The three main takeaways are taming inflation is job number one for the committee, the Fed Funds Rate needs to get to a restrictive level (3.5% to 4.0% depending on the Fed member), and the rate will need to stay higher until inflation is brought down to their 2% target thus cuts priced into the market for next year are premature. Chair Powell affirmed this guidance during his speech on Friday, yet, as expected gave no indication on whether they would do 50bps or 75bps at the September meeting.
Regardless of whether they hike 50bps or 75bps, as President Harker pointed out, 50bps is still a substantial size hike so it should not be taken as a dovish pivot as there is more work to be done on inflation and they will keep at it until the job is done. The committee will also have one more NFP report and one more CPI report prior to the September meeting that will influence their decision; as Powell stated, “the size will depend on the ‘totality’ of the data”.