28 AUG, 2023
By Constanza Ramos
During the meeting of bank representatives in Jackson Hole last week, Federal Reserve Chairman Jerome Powell addressed the topic of inflation and clearly stated his willingness to raise interest rates further in order to counter its rise. Experts from Carmignac, AllianceBernstein, Edmond de Rothschild AM, Generali Investments, and T. Rowe Price analyze the most significant points of this speech.
All eyes were on Jerome Powell today for confirmation of the Fed's impending change of course. However, instead of giving the 'green light' for inflation, Powell indicated the possibility of further hikes if growth continues to be above trend or the recent disinflationary trend comes to a halt. In our view, we do not think the Fed will hike in September, but the prospect of a hike in November remains open. For investors impatiently awaiting news of the eventual policy change, it looks like a longer wait.
I'm tempted to simply write 'nothing to see here, carry on', but given the interest in the speech, it's probably worth exploring that point in more detail.
Powell's speech is a big disappointment for anyone expecting him to break new ground or clarify the big monetary policy issues of the day. He did neither but chose to reiterate that the Fed relies on data and that there are risks in either going too far with rates or too little. If I had to pick a side, I would say that his comments are perhaps slightly 'hawkish', in the sense that he repeatedly emphasizes that the Federal Reserve will continue to fight inflation until it completes its task… but he has said this before and, in any case, he has not indicated whether this means further rate hikes or a longer period of rates at current levels. Both options are on the table, as they have been in recent weeks.
One issue that some expected him to address is the evolution of the 'neutral' interest rate. Currently, the Fed estimates this rate at around 2.5 percent; if this estimate were to rise, it would suggest the need for a more restrictive policy. In any case, Powell merely pointed out that "we cannot identify the neutral interest rate with certainty, so there is always uncertainty about the precise level of monetary policy tightening." No indication.
Another topic was the evolution of the growth outlook; with the summer data exceeding expectations, it might suggest that a data-dependent Fed would feel the need to raise rates further. Again, Powell was non-committal, merely pointing out that "further evidence of persistently above-trend growth could jeopardize further progress on inflation and could justify further monetary policy tightening." I interpret this as a signal that the Fed is not convinced that the summer rebound will last and, indeed, Chairman Powell pointed to slowing credit growth and weak industrial production as signs of a weaker outlook ahead. Again, no indication other than a reliance on data.
In short, the Chairman chose not to say anything that would influence the market and not to provide more clarity on the way forward. We should interpret this as a signal that the Federal Reserve is generally satisfied with the situation: it has the flexibility to respond to new information as it sees fit and reverting to a forward-looking policy is unnecessary and potentially counterproductive. Maximum flexibility is associated with minimum clarity, and that is what the Federal Reserve wants us to have now.
Europe had a mixed week as PMI data came in much lower than expected. The August composite index fell to 47 from 48.6 when analysts had expected 48.5. Manufacturing and new orders declined again, but the main disappointment was the drop in services, especially in Germany. Manufacturing and new orders were down again, but the main disappointment was the fall in services, especially in Germany. The figures send a clear signal to the ECB that its monetary tightening is starting to have the desired effect. There will now be calls for the bank to loosen soon.
For the time being, high-interest rates continue to affect the UK property sector, where Crest Nicholson issued a profit warning, citing worsening business conditions due to higher borrowing costs and lower demand for housing. The group sees no improvement before the end of 2023. Property platform Rightmove also said house prices had fallen 2% in the UK in a month, the biggest change in five years.
Following the results of 88% of MSCI Europe companies, CRH (cement) beat estimates and raised its forecasts. The group is continuing its share buyback program. In the video games sector, one man loses and another wins: the UK watchdog has not yet ruled on Microsoft's acquisition of Activision, but in a bid to win over the Competition and Markets Authority, the US group is to transfer the cloud gaming rights to Activision Blizzard's current and new games to France's Ubisoft for the next 15 years.
The S&P continued to consolidate in the absence of economic catalysts and ahead of the Jackson Hole central bank symposium. Yields on 10-year US Treasuries rose to a 15-year high of 4.32%, raising doubts about the possibility of a soft landing in the US.
Nvidia's results dominated the headlines. The microchip maker beat already particularly ambitious estimates with sales of $16.5 billion when analysts were betting on $11 billion. Operating profit was $7.78 billion, compared to the expected $5.89 billion. CEO Jensen Huang said the results were due to the huge demand for artificial intelligence solutions as data banks around the world switch to generative AI and faster, higher-performing chips. The group revised its third-quarter sales forecast to $16 billion, well above consensus expectations of $12.5 billion.
The picture was completely different in the retail sector. Foot Locker and Dicks Sporting Goods plunged -33% and -25% after posting lackluster figures. The results reflect the pressure on low-income households and dragged down other stocks such as Nike and Under Armour. On the other hand, Macy's (department store) gave a cautious outlook suggesting that consumer discretionary will have a more difficult fourth quarter.
Banking stocks were hit by downgrades from S&P and other rating agencies. Regional banks were the hardest hit.
Little comfort from Jackson Hole
At last year’s central bank summit at Jackson Hole, Fed Chair’s Powell hawkish turnaround pushed peak rates expectations to 4%. Today’s Fed Funds rate is close to 5.5%. However, a resilient economy and easing inflation have underpinned hopes of ‘immaculate inflation’, buoying risk appetite.
Yet, second thoughts have kicked in over August. A resilient US economy means high rates for longer. Markets have reduced the number of cuts priced for 2024, sending US yields soaring. Jackson Hole this weekend neither provided relief. Poor August PMIs showed worrying signs of major economies faltering (chart), but Powell and ECB’s Lagarde pledged to not give in prematurely on inflation, keeping rate hikes on the table. Robust evidence of sustained lower inflation is needed before they will consider any relief on rates. There is no room for flip-flopping after major central banks failed so spectacularly in fighting the inflation beast early.
This means tricky weeks ahead for risk assets. Economic data has yet to digest the full transmission of past rate hikes. Recent property woes in China are not helping either, weighing on risk appetite. At some point, central banks will nod and envisage easing steps for 2024. But the uncomfortable message from Jackson Hole is that the transition period over which inflation worries still trump cyclical ones may prove more protracted than market bulls might hope for.
Chairman Powell has just signaled that the Federal Reserve will proceed cautiously in considering the next rate hike. Importantly, his speech acknowledged stronger growth and a more resilient labor market than expected. He stressed that a period of below-trend growth is needed to bring inflation back on target. He emphasized that policy will remain restrictive until inflation declines in a sustainable manner.
The fact that the Fed will continue to depend on data and may raise rates again in response to strong growth and a tight labor market while maintaining a restrictive policy for an extended period, has important implications for Europe and the ECB.
First, unlike the US, there are clear signs that the European economy is sliding into recession. But the Fed could raise rates again this year and maintain the restrictive policy for an extended period of time. Ultimately, markets could price any Federal Reserve cuts further out on the curve than they are today. This would weaken the euro against the dollar, with the prospect of EUR/USD at 1.05. A weaker euro would provide relief to Europe's struggling manufacturing industry. However, commodity, food, and oil prices would become more expensive in euros. Inflation would remain above target for longer than previously expected. The ECB could therefore be forced to raise rates again or keep policy tighter for longer, despite the signs of weakness in output sent by this week's PMIs, to keep any further inflation resulting from a weaker euro at bay.
If US monetary policy remains restrictive for longer than expected, this will also be reflected in a rise in global bond yields, which poses a significant challenge to the debt sustainability of the European periphery. A permanently higher equilibrium interest rate and thus higher policy rates imply that US ten-year yields will remain at much higher levels than in the pre-pandemic decade. Italy's debt-to-GDP ratio now exceeds 150% and long-term growth prospects are weak. This carries the risk that markets will again perceive Italy's debt dynamics as unsustainable. This also means that it will be difficult for the ECB to fully release the BTPs it holds from its balance sheet. Because of these risks, the ECB's QT may therefore be more limited in scope than that of other central banks.
Powell's speech traced the progress of inflation since the Fed began raising interest rates in early 2022: inflation has fallen significantly, while the labor market has held up surprisingly well. But here is what matters most when it comes to the future path of interest rates: he noted that two months of positive data is not enough to give confidence that inflation will be on a sustained downward path. It became clear that he does not think the Fed's fight against inflation is over and that, given recent data, it is far more likely that the Fed's next move will be a hike than a cut.
Today we also learned of two potential triggers for the next interest rate hike: (1) signs of accelerating growth and an economy that continues to grow above its potential rate, and (2) signs that the labor market is not loosening any further and that the process of creating further slack has come to a halt. Powell's comments reiterated that the bar for a September hike is very high, but that the November meeting will also be a very important one.
Powell also reiterated that the Fed's inflation target remains 2 percent and that it is the Fed's job to bring it down, recalling the tone of his Jackson Hole speech last year. There has been a lot of pressure recently for the Fed to raise its inflation target. I expect the debate on this issue to intensify as the next Monetary Policy Framework Review approaches in a couple of years, but I don't think the Fed will give much support to this idea.
The initial market reaction has been an increase in the probability of another 25bp hike by November and a rise in yields across the curve, in line with Powell's message that rates could rise further and stay higher for longer. I expect that as we approach the November meeting, rates could rise further, in line with confirmation that the economy remains on track to expand over the rest of the year.
By RankiaPro Europe
By RankiaPro Europe