What to expect from Jackson Hole
We don’t expect a major “pivot,” but Jerome Powell could offer insight on three questions.
Our Top Market Takeaways for August 25, 2022
Market Update: Mountains, Gandalf
Wall Street is watching for the latest from Federal Reserve Chair Jerome Powell as he takes the stage at the annual Jackson Hole Economic Symposium on Friday morning. The symposium, which is like Burning Man but for central bankers, has been an opportunity for the Fed Chair to opine on the economic outlook and review how the Fed conducts monetary policy.
In 2020, Powell enshrined the average inflation targeting framework. Last year, he communicated why the Fed thought price pressures were transitory and it should take a gradual approach to tightening as it shot for maximum employment.
The debate heading into this year’s event is about whether Powell will make a dramatic policy “pivot” that would suggest a turn in Fed policy towards pausing the interest rate hiking cycle, or whether he will stick to the plan to continue rate hikes. Our view is that Powell will likely continue to signal further hikes from here given strength in the labor market and elevated inflation. At the same time, he will also probably suggest that the Fed will think about moving at a less aggressive pace.
So far this week, markets seem to be thinking that Powell will stick to the rate hiking script. Stocks have fallen and yields have risen. The 10 year Treasury is back above 3% and the 2 year, which is very sensitive to changes in perceptions about monetary policy, is now at its highest level since the middle of June.
Importantly, markets have been keeping their expectations for the Fed in 2022 relatively stable, but expectations for 2023 have been moving higher. Two months ago, market pricing suggested that the Fed would actually lower interest rates by over 80 bps in 2023. Today, the market is just expecting rates to fall by just ~40 bps.
This could be for good reasons or bad reasons. The bad reason would be that it will take higher rates for longer to get rid of inflation. The good reason is that it means the market is less worried about a recession given resilient hiring and consumer spending and signs that inflation pressures are abating. We lean towards the latter. Perhaps Chair Powell will offer some of his perspective on the matter at 10 am Friday morning.
Need-to-knows: Three things we are watching in Jackson Hole
Again, we aren’t looking for a dramatic “pivot”, we are looking for answers to three questions from Powell today.
1. What is the pace of hikes from here? The choice between hiking by 50 or 75bps in September will come down to the August employment and CPI reports, so it is unlikely that Powell will commit to a specific pace. But back in July Powell did indicate that, with the policy rate now in the ballpark for neutral, proceeding into restrictive territory implies a natural step-down in the size of hikes should inflation data cooperate. Said another way, the Fed needed to get to “neutral” as quickly as possible, but now they can afford to take a more data-driven approach. On that note, the data since then have provided a mixed-bag: softer price data but strong labor market numbers. We’ll be looking for any updated thoughts on where the Fed sees neutral and restrictive rate levels and if Powell still feels a slower pace should be the baseline.
2. What kind of slowdown in inflation would be enough for the Fed to pause? In June, the headline PCE deflator rose 6.8% year-over-year and core PCE deflator 4.8%, both well-above the 2% target. If June represents the peak in inflation, how far does it need to fall for the Fed to feel comfortable pausing? More specifically, would it require a 2% year-over-year rate or would a string of month-over-month prints in the 0.2% area combined with weakening growth data be enough to allow the Fed to pause after it has reached a restrictive rate? The former seems difficult to achieve without a hard landing while the latter would probably be much more growth and risk asset friendly.
In the past, Powell has used vague phrasing on their inflation goal: “clear and convincing evidence that inflation pressures are abating and inflation is coming down”. We’re watching for any more specific signposts, especially how consumer price data will be considered alongside the full constellation of labor market, growth and inflations expectations indicators, but our sense for now is that the Fed will eventually pause before year-over-year CPI is back below the 2% hard-deck.
3. How does a bleak growth outlook factor into Fed policy? The Fed clearly wants to see growth slow in order to bring down inflation. But is there a trigger point in growth or labor market data that would cause it to slow rate hikes or pause? Despite some ugly numbers from the housing sector, a slight rise in initial jobless claims, and ugly sentiment based measures, there is no hint that we are close enough to a break point in growth. In fact, economic surprises in every sector but housing and surveys have been positive recently. While we seem far away from the growth floor now, any clarity from Powell on this front would be important.
Overall, we aren’t expecting a big shift from Powell on Friday, but there seems to be a subtle change coming in how the Fed will probably act. The pace of rate hikes should slow down, and there should be at least a touch more focus on how higher interest rates are impacting economic growth. Both should help calm market volatility at the margin.
Please reach out to your JPMorgan team for more on how we are navigating the current economic and interest rates environment.
All market data from Bloomberg Finance L.P., 8/24/22.