Markets Stumble Into Jackson's Hole
Jay Powell’s speech at Jackson Hole last Friday may have been brief but was unambiguous, leaving aside any mention of the Fed’s dual mandate, focussing instead on the need to restore price stability.
“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth.”
This was for the determination and focus…
“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
This was for the Fed’s readiness to lower the strike of the Fed “put” on financial markets.
The power of the Summer’s rally were somehow mocking the Fed’s resolve to further hike interest in a meaningful way to stave off inflationary pressures. The Fed chose Jackson Hole to clarify its intention, pushing back against market expectations of a loosening of monetary policy in 2023.
The market was quick to adjust last Friday to this new reality, causing much of the 4% weekly decline in major equity indices.
Time will tell how long the Fed’s resolve will last but it spoke in no uncertain times last Friday and markets had to take notice and have been warned. US. private-sector business activity contracted for a second straight month in August to its weakest in 27 months with particular softness registered in the services sector as demand weakened in the face of inflation and tighter financial conditions, Reuters reported.
At the same time, real estate dynamics are pointing downwards, judging from the sharp decline of new U.S. single-family homes to a 6-1/2-year low and price declines in certain hot areas of the US market. Home prices declined 0.77% from June to July, the first monthly fall in nearly three years. At the same time, this year, 420,000 apartments are expected to be delivered in the US which will be the second year in a row that the industry tops 400,000 units, a mark that was last reached in 1972, Bloomberg reported.
Mortgage demand continued to weaken, still right around a 22-year low (as mortgage rates doubled this year), despite a jump in demand for loans offering lower down payments.
Consumers on their part are drawing on their credit cards to make ends meet with the confidence of the US consumer weak and getting weaker as stock market’s gains started to fizzle.
As a result, the US recession remains likely, if not unavoidable, and the Fed remains likely to pivot in our view with only timing more uncertain by a few months. The Fed put has likely not been abandoned, but its strike has most likely been lowered.
Some European Central Bank policymakers were also said on Friday to want to discuss a 75-bps interest rate hike at the September policy meeting, even as recession risks loom, as the inflation outlook is deteriorating, five sources with direct knowledge of the process told Reuters…
Over the weekend, more hawkish Central Bank speak emanated from Jackson Hole while two dissenting voices spoke over the weekend against the Fed’s resolve.
J. Stiglitz made the point that raising rates is not a “supply side” solution, meaning that higher rates will not make food or energy or chip supplies more readily available and argued that raising rates could even make matters worse, raising the price of required additional investments.
Elizabeth Warren took aim at the Federal Reserve’s inflation-fighting game plan yesterday, saying she was worried the central bank will tip the US economy into a recession.
With stock markets hedges unwound by weeks of a restless short squeeze, more equity markets weakness remains likely in the short term amidst heightened geopolitical and climate change (extreme drought) concerns that are likely to aggravate upward inflation and downward economic pressures.
Bonds are unlikely to find much comfort from falling equities this time as they need to grasp the reality of higher rates for longer as well. What worked in the past may continue not to work this year with bonds expected to offer little respite to suffering equity investors.
According to Refinitiv Lipper, investors sold a net $10.48bn worth of global equity funds last week, from just $3.15b purchases over the prior week. The IPO market is on pace for its worst year in decades as well and Bloomberg reported that Global banks are stuck with $80bn in unappealing M&A financing debt as well.
With no respite to expect from the war front, Moscow said it saw no possibility of a diplomatic solution to end the war in Ukraine and expects a long conflict. Last week, Vladimir Putin signed a decree to increase the size of his country’s armed forces by 137,000, or about 10%, to 1.15 million. As the energy crisis raged, J. Biden signed another multibillion cheque in support of the war at the same time as its administration started to pressure US oil companies to reduce exports to Europe to cope with dwindling US domestic reserves.
If the situation was not dire enough for Europe, the bloc is currently in the throes of the worst drought in at least … 500 years, according to a preliminary analysis by experts from the European Union’s Joint Research Center with some 64% of the EU under a drought warning or alert.
At the same time, China continues to expand its reliance on Russian energy, with purchases of crude, oil products, gas and coal rising to $35 billion since the war in Ukraine began, from about $20 billion a year earlier… Imports in July included a record haul of Russian coal, making Russia China’s top supplier of coal as well.
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Over the past week, the S&P500 sold off by -3,7% (-14,4% YTD) while the Nasdaq100 sold off by -4,2% (-22,2% YTD, Z-score -2,1). The US small cap index sold off by -2,9% (-15,0% YTD).
CBOE Volatility Index rallied 21,7% (45,5% YTD, Z-score 2,5) to 25,56.
The Eurostoxx50 sold off by -3,4% (-14,1%, Z-score -2,8), outperforming the S&P500 by 0,2%.
Diversified EM equities (VWO) gained 0,6% (-15,5%), outperforming the S&P500 by 4,3%.
The Dollar DXY Index (UUP) measuring the USD performance vs. other G7 currencies gained 0,7% (13,7%) while the MSCI EM currency index (measuring the performance of EM currencies vs. the USD) dropped -0,1% (-4,9%). CNY slumped to its weakest against the dollar in almost two years, despite China’s government unveiling tens of billions of dollars of economic support for its power and agricultural industries in an effort to counter the damage from repeated Covid lockdowns and a property market slump.
10Y US Treasuries underperformed with yields rising 7bps (153bps) to 3,04%. 10Y Bunds climbed 16bps (157bps) to 1,39%. 10Y Italian BTPs underperformed rising 20bps (253bps) to 3,70%, underperforming Bunds by 7bps.
US High Yield (HY) Average Spread over Treasuries climbed 22bps (163bps) to 4,46%. US Investment Grade Average OAS climbed 2bps (47bps) to 1,47%.
In European credit markets, EUR 5Y Senior Financial Spread climbed 10bps (66bps) to 1,21%.
Gold dropped -0,5% (-5,0%) while Silver dropped -0,9% (-19,0%). Major Gold Mines (GDX) dropped -1,8% (-22,6%, Z-score -2,5).
Goldman Sachs Commodity Index rallied 2,1% (35,9%). WTI Crude rallied 2,5% (23,7%).
Overnight in Asia,,,
S&P500 -36 points; Nikkei -2.8%; CSI300 -0.9%
Have a nice week ahead and be good to yourself !
Marc Bentin, BentinPartner GmbH
Chief Investment Officer
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Marc Bentin serves as Economic Advisor to Blue Lotus Management,
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