The Federal Reserve is holding its annual Jackson Hole meeting in Wyoming, with investors expecting the U.S. central bank to ramp up its efforts to tame record-high inflation by maintaining its tight monetary policy.
The expectations came after the Fed last week released minutes from the July meeting, showing that the bank is considering adopting a more dovish stance, which increased the appeal of risk assets for a brief period.
Equities and bond yields held their ground initially, although the S&P 500 still closed 1.2% lower on the week. On the other hand, the benchmark 10-year Treasury yield advanced around 10 basis points (bps) above 3%.
The US benchmark index recovered early this month after the latest consumer price index (CPI) print showed that inflation may have finally peaked. However, consumer prices still remain at 4-decade-high levels, and the latest minutes release suggests that the Fed plans to stick to its high-interest rates policy.
The Fed has implemented two consecutive 75 bps rate hikes at its last two meetings, with one of the biggest Wall Street debates now being whether the central bank is preparing a third 75 bps increase. The central bank also intends to raise the pace of its balance sheet reduction next month and roll off $60 billion in assets each month, up from $30 billion.
All Eyes On Powell
The Fed’s chairman Jerome Powell is expected to set the market tone at the Jackson Hole symposium on Friday. The market volatility is likely to be dictated by Powell’s speech until the next Federal Open Market Committee (FOMC) takes place in mid-September.
Barclays analysts warn that the ongoing rally in equities is at risk as Powell prepares to deliver a much-anticipated speech on Friday.
Analysts wrote in a note last week:
“The key for equities is whether Powell will push back against the view of a 2023 easing cycle and guide towards a higher terminal rate, or if he keeps optionality.”
Standard Chartered’s Steven Englander noted that “caution and fear” are the current themes in the market. He added:
“If Powell says something hawkish and if you buy equities or emerging market currencies, you’ll lose 3% before you can blink your eye. So nobody is buying risk right now in the run-up to Jackson Hole.”
In its minutes, the Fed said it noticed scant evidence that inflation eased in July, but the central bank acknowledged that overly tight monetary policy could impede economic recovery.
Fed Fund futures projected a 51% chance for a 50-bps interest rate hike in September, with the fed funds rate reaching 3.6% at the end of 2022. This compares to the futures market’s previous forecast of a 75-bps hike prior to the minutes’ release.
Simplify Asset Management’s managing partner Harley Bassman believes current rate futures pricing is far from accurate. Bassman believes the Fed will introduce a higher-than-expected rate hike next month as he doesn’t think inflation will ease to the 2%-3% target range in 2023.
“It’s baked in the cake,” he added.
Somewhat eased fuel costs did not drive the U.S. consumer prices further in July. However, underlying price pressures remained high. Lower energy prices also pushed down producer prices last month.
Some asset managers believe the Fed is prepared to do whatever it takes to bring down the red-hot inflation to the desired 2% level, though he does not expect the central bank to implement all the hikes in just a few meetings.
The number of net long positions on the U.S. dollar is on the rise for the first time in four weeks as investors brace for the Jackson Hole meeting, according to new U.S. Commodity Futures Trading Commission (CFTC) data. Englander said the “market is panicking” as the meeting draws near.
U.S. Dollar Could Extend Its Bull Run
Some investors expect the Fed to loosen its monetary policy because the economic activity is slowing down, but others believe that Jackson Hole will prove them wrong.
LPL Financial head economist Jeffrey Roach is one of those who think that the Fed will maintain its aggressive approach, citing a mid-1990s tightening cycle when the central bank retained its high-interest rates to address the weak labor market. Roach said:
“There is still a chance for the Fed to stick a soft landing here.”
Talking about whether the Fed will issue another major interest rate hike in September, Chairman Jerome Powell said:
“That is a decision that will depend on the data we get between now and then.”
Heading into the Jackson hole meeting, the U.S. dollar is again headed for the two-year high. Some investors expect Powell’s speech later this week could boost the U.S. dollar index, which recently tested the 19-year high of 109.29.
At this point, the greenback stands a good chance to continue gaming traction against a basket of currencies as the 10-year Treasury yields hold its 3% level. Still, the dollar’s prospects largely depend on Powell’s speech.
Wall Street giant JP Morgan believes Powell will be more likely to hint at easing rate hikes:
“We expect the Fed to become more sensitive to softer activity dataflow now that they have moved policy rates above what was historically considered as neutral. September could be the last of the outsized Fed hikes.”
On the other hand, analysts at Goldman Sachs think that Powell will reiterate his previous message that the Fed will not stop fighting until inflation is down to the 2% target, and that upcoming interest rate decisions hinge on new CPI data.
If JPMorgan’s predictions prove correct and Powell does suggest a more dovish approach in the coming months, it could seriously impede the dollar’s rally and push down the greenback, potentially ending one of its strongest bull runs in recent history.
Summary
Fed’s Chair Powell is due to give a speech at the annual Jackson Hole event on Friday, a closely monitored meeting due to its impact on the markets. Raging inflation and the consequent rate hikes are the primary reasons why nearly all capital markets are down this year.
Any hint by Powell that the Fed may slow down its aggressive tightening policy will be interpreted as a “dovish pivot” by the Fed. At the same time, a more hawkish Powell is likely to end the ongoing stock rebound and initiate the next leg lower.