Jackson Hole Preview: Expectations for Powell, the "Wild Card", and Implications for Asset Classes

"Economic expansions don't die of old age; they're murdered by the Federal Reserve"

Over the past two years, Fed Chair Jerome Powell has been unwavering in his commitment to fighting inflation, even at the risk of triggering a recession. As he stands on the verge of potentially achieving this goal without derailing the economy, the coming months will be critical. Powell's upcoming speech at the Jackson Hole Symposium will be closely watched as it may reveal his strategy for navigating the final stages of the Fed's inflation battle.

The Jackson Hole Symposium is an annual economic conference organized by the Federal Reserve Bank of Kansas City, held in Jackson Hole, Wyoming. It is a prestigious gathering that brings together central bankers, economists, and policymakers from around the world to discuss key issues related to the global economy, monetary policy, and financial markets. The event is highly influential, as speeches and discussions, particularly by prominent figures like the Chair of the Federal Reserve, often provide insights into future economic policies and are closely watched by financial markets.

Two years ago, Powell addressed Jackson Hole with a somber message, invoking the legacy of former Fed Chair Paul Volcker and signaling his readiness to accept a recession as the price for taming high inflation. At that time, the Fed had paused after raising rates by 225 basis points between March and July. Participants believed the Fed was done raising and was caught off guard. Powell even used the phrase "keeping at it" which happened to be the title of Volker's recount of his aggressive rate hike plans. 

The Fed would go on to deliver rate hikes of 75 bps, 75 bps, and 50 bps over the final three months. After the Jackson Hole speech, the S&P 500 fell sharply, continuing to decline through September. The index saw some recovery in October and November, but overall, it ended the year down approximately 10-15% from the levels seen at the time of the Jackson Hole speech.

Now, as the Fed's inflation fight enters its final phase, Powell's approach at this week's conference in Wyoming will be pivotal. His success or failure could redefine the narrative around the Fed's delayed response to inflation in 2021, challenging the notion that the costs of their cautious approach were as severe as some critics feared

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Will a dovish speech spark a rally this time around?

Market Expectations

Fed members have indicated their readiness to start cutting rates at the upcoming September meeting, as inflation pressures ease and the job market cools. However, there is ongoing debate within the Federal Reserve about the pace of rate cuts.  

Within the Fed, there are differing views on the timing and extent of rate cuts. One camp, including Fed Governor Michelle Bowman and Kansas City Fed President Jeff Schmid, is cautious about cutting rates too soon, fearing it could reignite inflation or cause it to settle above the 2% target. They argue that with unemployment still low, there is no rush to reduce rates significantly. This group is skeptical about concerns over the labor market, attributing recent unemployment increases to temporary factors. 

On the other hand, another camp is more concerned about becoming too complacent with the slowdown in labor demand, questioning the delay in rate cuts, given that inflation-adjusted interest rates are at their highest level in decades.

The release of the Fed minutes from the July 30-31 meeting revealed a generally dovish tone within the Federal Reserve, with many participants advocating for more aggressive rate cuts. 

As we know, the Fed decided to maintain the federal funds rate at the current range of 5.25% to 5.5%, citing recent progress on inflation but indicating that more evidence was needed before considering a rate cut. However, the vast majority of participants suggested that if economic data continues to trend as expected, it would likely be appropriate to ease policy at the next meeting.

While all participants supported maintaining the policy rate within its current range during the July meeting, several noted that recent progress on inflation and rising unemployment provided a plausible case for a 25-basis-point rate cut, suggesting they could have supported such a move.

The CME Fed Funds Futures saw expectations for a 50 basis points cut rise to 38% from 25% following the release of the minutes as well as revisions to the BLS data. However, we have seen those expectations reverse course today.

The market's movements suggest that participants expect Powell to adopt a dovish tone, while avoiding any direct indication that the Fed plans to cut rates at the next meeting. Instead, he is likely to emphasize that the Fed is prepared to act in September if the upcoming data continues to show weakening trends in inflation and the job market.

Economic Data

Concerns about the labor market have raised questions about the timing of potential rate cuts. While inflation has fallen significantly from above 7% two years ago to around 2.5%, close to the Fed's 2% target, the unemployment rate has risen from 3.7% at the start of the year to 4.3% in July. Although this is still a historically low level, there is concern that a small increase in unemployment could lead to a larger rise, suggesting a need for the Fed to consider lowering rates more quickly. The U.S. economy has managed to avoid a recession despite higher rates, but signs are emerging that the factors which have supported this resilience, such as pandemic-era savings and an immigration-driven spending boost, may be diminishing.

The outlook for the U.S. housing sector is particularly concerning. While it initially avoided a downturn due to a limited supply of homes on the market, this dynamic is changing as inventories rise and the apartment construction boom comes to an end. The number of housing units under construction has fallen nearly 10% over the past year, the largest decline since 2011. In the labor market, hiring has slowed, and while layoffs remain low, there is a risk that the controlled reduction in labor demand could overshoot. Additionally, the Labor Department's recent report indicates that payroll growth for the 12 months ending in March could be revised down significantly, suggesting that job gains for much of 2023 and early 2024 were weaker than initially reported.

The recent release of benchmark revisions for U.S. non-farm payrolls, covering the year ending in March 2024, revealed a significant downward adjustment, trimming 818,000 jobs from initial estimates. This revision has reduced the monthly average job gains from 242,000 to 174,000, raising concerns about the true state of the U.S. labor market. 

These revisions have significant implications for both markets and policymakers. For the Federal Reserve, the weaker-than-expected job growth may prompt a reassessment of the labor market's strength, potentially leading to more accommodative monetary policies. Investors, meanwhile, face a more complex economic landscape, with the revised data adding uncertainty to market sentiment, particularly in economically sensitive sectors. 

The market will see a few key reports ahead of the Fed's September 17 meeting. These include PCE data (8/30), ISM Manufacturing (9/3), ISM Services (9/5), August jobs report (9/6), and CPI (9/11). Collectively, these reports will help shape market expectations between a 25 or 50 basis point rate cut. 

The Wild Card

Bank of Japan (BOJ) Governor Kazuo Ueda is currently one of the most influential figures in global markets due to his influence over the yen carry trade, which has had significant impacts on financial markets. 

Ueda surprised markets on July 31st with a rate hike and hinted at more to come, causing a sharp 6% drop in the S&P 500 over the following days. However, after Deputy Governor Shinichi Uchida later suggested that further hikes might be delayed, the S&P 500 rebounded by 7%, highlighting the profound influence Ueda's decisions have on global financial stability.

As Ueda prepares to testify before the Japanese Diet on Friday, just hours before Fed Chair Jerome Powell's speech at Jackson Hole, markets are on edge. Ueda is expected to navigate this appearance carefully, aiming to avoid further market volatility while addressing lawmakers' concerns about the BOJ's hawkish stance, which previously triggered a significant market rout. The carry trade, influenced by BOJ policy, is crucial because it affects global liquidity and investment flows. Ueda's comments will be closely watched for any indications of future rate hikes, with the potential to either strengthen the yen and cause stock markets to tumble, or weaken the yen and reignite concerns that existed before the July policy shift.

The spread between the USD and the JGB will be critical for the carry trade. It appears that the US 10-year rate versus the 10-year JGB has technical support at an interest rate spread of 2.9%. If the spread falls below this support level, it could lead to a further narrowing of the interest rate differential, potentially strengthening the yen and driving the USD/JPY lower.

USD/JPY is trading around 145.20 on Thursday, consolidating under a downtrend line, indicating a bearish bias. The 14-day RSI is slightly above 30, hinting at a potential correction. Key support levels include the psychological 144.00 level, with a break potentially leading to the seven-month low of 141.69 and further to 140.25. On the upside, immediate resistance is at the downtrend line around the nine-day EMA at 146.45, with a breakthrough possibly weakening the bearish bias and allowing a test of the 154.50 resistance level.

It will be critical for investors to watch for Ueda comments and how it impacts the carry trade dynamics. If Ueda does strike a slightly more dovish tone, or at least signal that the BoJ is on hold, then that would allow for Powell to proceed with a dovish message.

However, if we see Ueda strike a defiant hawkish tone, would that potentially influence Powell to sound a little more hawkish as well? We will see but it is an interesting dynamic which investors need to be aware of.

Our Expectations for Asset Classes

Taking into consideration all factors, here is our baseline scenario for Powell's speech at Jackson Hole:

The commentary from the Fed minutes suggests a growing sentiment behind a potential rate cut. Current monetary policy is well above the neutral rate, and Fed Chair Jerome Powell has repeatedly stated that it is restrictive. The Fed has emphasized its data dependency, and recent economic reports indicate the possibility of loosening rates to give the economy, particularly interest-rate-sensitive sectors like housing, some breathing room. The job market has shown signs of weakening, and the significant downward revision in BLS figures yesterday suggests employment may be even weaker than previously thought. While inflation remains above the 2% target, all signs suggest it is trending lower. There are concerns that inflation could pick up, but the trend continues to favor the dovish perspective.

The evidence points towards a more dovish Powell tomorrow. The baseline scenario suggests that Powell will indicate the central bank is prepared to move forward with a rate cut at its next meeting. There may be a caveat, such as "if we see data continue to trend as expected, then we will cut rates," which would heighten volatility around the mentioned economic data. However, the underlying expectation is for Powell to strike these dovish notes.

Several variables could still impact markets—such as the yen trade, Nvidia earnings, and geopolitics—but our expectations for asset classes, assuming Powell delivers the baseline commentary, are as follows:

• Stocks: Equities would likely respond positively to a dovish Powell. While there is a risk of an immediate dip, the prevailing bullish trend should persist. We would be inclined to buy any potential pullbacks, expecting indices to trade higher heading into the September 17 meeting.

• Gold: Gold should continue its upward trend. The biggest tailwind for gold remains geopolitical uncertainty around the elections, with neither candidate proposing economic policies that would be seen as deflationary.

• Bitcoin: Bitcoin has been consolidating within the $54-70K range. Despite a few obstacles, we believe it should move towards the higher end of the range if the Fed is expected to cut rates.

• Housing Stocks: This sector would clearly benefit if the Fed is ready to cut rates. Additionally, some of the economic policies proposed by Kamala Harris could attract more investors to this area in the coming months. While the job market may pose a potential headwind, this group remains undervalued and should benefit from rate cuts.

• Utilities: This group remains attractive despite recent gains. A part of the tailwind has been the perception of this sector as a "sneaky" AI play, with investors seeing the need for energy around AI products as a key positive factor. Lower rates would further boost these companies as potential income generators, leading to additional upside potential.

• Real Estate- The beaten down sector has been a laggard, but the specter of interest rate cutting cycle would lead to more money to flow into the space. The chart looks great and investors should expect further upside as a rate cutting cycle gets underway.