The last days of summer in America will, as usual, be dominated by a smallish gathering of very important people in a high-end fly-fishing resort in Wyoming. The annual Jackson Hole economic symposium might look like a talking shop for policy wonks, but it has evolved over the past 45 years into a key market event. All investors’ eyes will be on this beautiful spot in the Rocky Mountains when Fed chair Jerome Powell stands up to speak.
This year’s summit is particularly important because it is expected to provide guidance on the key market questions facing investors today - what happens next for US interest rates and when? Is the US Federal Reserve (Fed) done with the remarkable monetary tightening cycle that has overshadowed markets for the past couple of years? And if it is, how long before the US central bank believes it can safely call time on the post-pandemic inflation surge and take its foot off the interest rate brake? We should know a lot more by the weekend. But if last year is any guide, markets could be volatile as investors dig into the detail of Mr Powell’s keynote speech.
A year ago, the S&P 500 hit an air pocket as markets assessed a short but punchy message from the Fed chair. His words took the wind out of the sails of a powerful rally in the middle of 2022’s bear market, setting up the final down leg to October’s low point. What he said was really just a statement of the blindingly obvious - that getting on top of inflation would require higher for longer interest rates, a slowdown in the economy and rising unemployment. Just as had been the case 40 years earlier when Powell’s predecessor at the Fed, Paul Volcker, won his battle with inflation, victory would not be painless, he said.
Volcker casts a long shadow over Jackson Hole. When the symposium moved to its current home in 1982, it was in large part to ensure that the Fed chair would attend the event. He was a keen fly fisherman when he wasn’t busy clearing up the mess left by his predecessor Arthur Burns. It was Burns who allowed prices to spiral out of control in the post-Vietnam inflation crisis of the 1970s. Powell’s task is arguably easier than Volcker’s, but no less important. He knows that his legacy, and the credibility of the central bank he heads, is at stake this week.
Powell’s speech is not the only thing happening at Jackson Hole this week. The summit is an opportunity for policy makers from around the world to get together to discuss the weighty matters of the day, and this year’s focus is on ‘Structural Shifts in the Global Economy’. So, there will no doubt be plenty on China, Russia, artificial intelligence, and much else. But what most investors are tuning in for is the subtle hints that Powell’s carefully crafted words will convey. They will be hoping for something more reassuring than last year’s nine-minute cold shower.
What should we expect this year? Things have certainly moved on in 12 months but not exactly as Powell or the markets might have anticipated. The reason the market reacted so badly to Powell’s words a year ago was the not unreasonable assumption that the Fed was prepared to push the US into recession if that is what was required. But the US economy has proved unexpectedly robust since last August. And investors have had to get used to a different narrative. A year ago, it seemed plausible that the Fed would tighten hard but then pivot rapidly to easier policy as it became clear that it had squeezed too aggressively.
Today, with a still hot labour market and a US consumer that refuses to lie down, it remains valid to ask whether the Fed has squeezed hard enough.
The run up in bond yields this week indicates that the market thinks interest rates could rise a bit further yet. With the ten-year yield at 4.3pc and the two-year touching 5pc, investors are pricing in another quarter point hike, perhaps at the November meeting. And no-one really expects rates to start coming down again until next summer at the earliest in the absence of a more significant slowdown than now looks likely. The relationship between those short and long bond yields - the yield curve - continues to point to a recession, but there’s precious little evidence on the ground.
The trajectory of interest rates this year has been a salutary reminder of the risks of trying to time the market. At the start of 2023 it looked reasonable to expect the Fed to be toying with a first interest rate cut by now. The pivot has been pushed out by at least a year and the peak will be higher than previously thought. The idea was that government bonds would be a good investment thanks to the double whammy of locking in an attractive yield and then benefiting from a capital gain as rates started to fall again. The thinking looks good, the timing less so.
The minutes from the last Fed meeting gave us a clue to the Fed chair’s current thinking. ‘We’ll be comfortable cutting rates when we’re comfortable cutting rates, and that won’t be this year I don’t think’ was how he framed it. So, no-one should expect any immediate talk about rate cuts, even if there is less finger-wagging from Powell this year. He’s done the hard part for any central banker, managing expectations. Time to enjoy the mountains.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
