Evening Brief – 08.21.23

In the Mountains of Wyoming

The Federal Reserve’s Jackson Hole Economic Symposium is the key event for the financial markets this week. This year’s theme is “Structural Shifts in the Global Economy,” with Chair Jay Powell’s address on Friday simply titled “Economic Outlook.”

Unlike last year’s speech, most economists do not expect Powell to convey significant indications about the near-term direction of the central bank’s monetary policy.

But Powell has delivered several crucial long-term policy messages in recent years. Last year, he delivered a rather brief and unambiguous statement on the need for price stability, which left no doubt about the Fed’s determination to return inflation to its 2% goal.

This year’s meeting takes place at an unusual time. Nominal and real yields have increased significantly. However, certain other indicators of general financial conditions remain quite loose. Bloomberg’s gauge of US financial conditions is currently more accommodative than its historical average.

Furthermore, the solid US economic data in recent weeks has bolstered the soft-landing case. However, the worry is that, with the data coming in so strong, real rates continue to rise, increasing the likelihood that something may break, as has frequently happened during previous Fed hike cycles.

FOMC members are busy determining how much further tightening the economy requires, while economists continue to determine where the neutral interest rate rests. Powell may be content with the odds on another rate hike as long as it keeps traders from pricing in rate cuts, which would effectively soften the monetary policy stance.

There is still a risk of doing too much or too little to combat inflation, and the more traders price rate cuts, the more likely it is that central bankers will have to raise rates more than they anticipate.

As for the price action, the equity markets appear in limbo as we start the week. While most indices broke below their closely watched 50-day moving averages, which has been strong support since the middle of June in the DJIA and late March in the S&P500, it has not opened the floodgates yet to increased selling pressure. At the same time, volatility remains subdued.

Meanwhile, the global government bond markets have picked up where they left off last Friday. The long end continued it selloff, with the US 10-year yield reaching 4.35%; its highest level since November 2007. The 30-year yield hit 4.41%; its highest level since 2011.

At the same time, the yield curve continued to bear steepen, reaching –65 basis points; it was –91 basis points only three weeks ago. This is not the type of steepening we want to see, as it usually comes before an economic slowdown.

If you’re Powell and you haven’t finished drafting your Jackson Hole speech yet, or if you’re modifying it at the last minute like last year, you must worry that the market is suggesting we’re approaching a structural regime of higher rates, or that the market is concerned about China’s bond holdings.

We’ll have to see how the surge in bond yields, especially at the long end, will play out in the mountains of Wyoming.