Jackson Hole and the Lack of Decisiveness in Policy

Once a year, economists head to Jackson Hole in August to see discussions on the current economic situation and policies; along with specialized academic research. Meanwhile, the market focuses mainly on the speeches of the governors of major Central Banks to gauge their stance on monetary interest rate policies in the coming time.

This weekend's Macroeconomics article from Viet Hustler will take a popular approach and discuss with 2 key points:

• Summary of the basic content in J.Powell's speech and the Fed's stance on interest rate policy.

• Market discussions revolve around the direction of inflation and interest rate policy from the Fed, and Viet Hustler's view.

Highlights from J.Powell's speech at Jackson Hole 2023.

Governor J.Powell's speech at the Jackson Hole Economic Symposium clearly shows that the Fed is trying to find a balance between price stability goals and market stability:

• Fed is ready to raise interest rates higher if necessary and intends to maintain a tight interest rate policy stance until the Fed ensures that inflation is gradually declining to the target level (2%)...

  

• But the Fed will also carefully consider interest rate decisions cautiously....

  (May continue to raise interest rates or may pause to monitor... entirely dependent on economic data.)

  

• The Fed is currently closely monitoring the housing market and rental prices:

  ... if rental price growth returns to stable levels near pre-pandemic levels, then housing services inflation will also decline to pre-pandemic levels...

• In addition, the Fed clearly states its stance to keep the target rate at 2%=, refuting all market calls to raise the target interest rate level. 

• Full speech of J.Powell here. 

=> Overall, the Fed is tough on policy goals to curb inflation while also somewhat relaxed and soothing due to concerns about risks from the financial markets.

=> In particular, there is no firm confirmation on raising or cutting interest rates through this speech.

Why are the market and the Fed concerned about the possibility of inflation not being curbed?

• Inflation is still high, this is still the Fed's assertion as core PCE growth remains at +4.3% y/y.

  

• Moreover, the chart below is the reason many analysts are worried, as the chart shows that the current inflation trajectory somewhat resembles the stagflation period of the 1960s-1980s:

  Inflation cools but continues to rise after 2 years due to the Fed pivot (cutting interest rates) too hastily.

  

• This was also the main concern in Powell's speech last year (at Jackson Hole 2022) when he emphasized the risk of interest rate policy not being carried through to fully curb inflation.

  • Viet Hustler's old analysis article for last year's Jackson Hole. 

However, according to Viet Hustler, up to now, the current inflation situation cannot be compared to the 1960s-1980s period. Because the current inflation situation and economic environment are vastly different from the 1960s-1980s in 3 points:

• The current global economy has a more integrated trend with the explosion of e-commerce. China's accession to WTO, trade between economies, and online shopping make price comparison tools more available to consumers. This makes prices more easily adjusted back to normal levels.

• Both inflation periods (current and 1960s-1980s) originate from shocks in the crude oil/energy market. 

  • But the weight of the impacts from the crude oil price shock on inflation in the 1960s-1980s period was much higher and more prolonged than the impact of the energy price shock on current inflation:

    • In the 1970s, after inflation was gradually controlled, oil prices continued to triple, causing inflation to rise again uncontrollably...

    • Meanwhile, currently, the US is controlling crude oil and energy prices quite well despite UAE's oil supply cut last year.

      Meanwhile, Europe is also doing quite well in energy independence at the current time.

• Labor productivity at the current time far exceeds that of the 1960s-1980s period, supported by AI and new technologies.

In addition, the inflation shock index from Citibank is at its lowest level since April 2020:

• ...which means that factors that could cause major price shocks such as wars, pandemics, supply shocks... are not as severe as before...

What could make the Fed consider the possibility of pausing the interest rate hiking process to monitor the market?

Regarding the issue of rental prices and housing cost inflation: it can be said that rental prices in the market are gradually “normalizing” to pre-pandemic levels as the Fed expects (chart below):

• …signaling that housing inflation will decrease to normal levels in the coming time. 

• This could be one of the drivers making Powell adopt a softer stance on interest rates in this speech.

In addition, the Fed's softness may come from the possibility the economy is cooling down, purchasing power and consumer demand are on a downward trend…

• JPMorgan estimates that consumer spending from bank cards decreased -0.24% m/m in the first half of August 2023.

  (a significant decrease compared to the +1.00% m/m increase in July).

  

• While August is still a travel month and travel movement activities are no longer disrupted but have returned to normal as in the pre-Covid period. 

  

• The average yield of CDS (considered as insurance premium for default risk) in the retail sector is increasingly rising…

  (due to concerns about the deteriorating consumer situation once people exhaust their savings and return to paying student debt …)

  

Finally, if the Fed continues to raise interest rates too high, the pressure on Treasury bonds will increase, making the public debt situation even more severe. 

• The US budget deficit is exploding more than ever…

  

• While debt servicing costs are increasingly rising for the US government…

  

• The real estate market is also suffering heavy impacts from the Fed's high interest rate policy.

  • According to Bankrate, the 30-year fixed purchase mortgage rate in the US has risen to 7.62% at the beginning of last week, which is the highest mortgage rate since September 2000.

  

Predicting the direction of the Fed's interest rate policy

• Currently, the market still predicts an 80% chance that the Fed will skip the rate hike in September 2023 (keep the current rate) to observe more economic data. 

  (Although the market has increased the odds to 20% chance of the Fed hiking rates by another +25bps, compared to only 11% last week).

  

• Futures market shows that the market expects (only) one more rate hike this year and the Fed will start cutting rates in February 2024.

  

However, Viet Hustler thinks the market is somewhat overly optimistic. The Fed may limit raising rates “higher” but will keep rates high “for longer”, until core inflation (core CPI and PPI) returns to near 2%... 

CONCLUSION

It can be said that compared to last year's speech with the sensational phrase “higher for longer”, this year's speech by J. Powell at Jackson Hole is somewhat softer. Through Powell, the Fed does not clearly show the direction on interest rates in the near future. 

• On one hand, Powell focuses on showing a tough stance to achieve the price stability goal and will maintain the 2% target rate. 

• On the other hand, Powell emphasizes that the Fed will carefully consider appropriate interest rate decisions based on economic data to soothe the market.

Those “technical analysts” say that current inflation may follow the 1960s-1980s situation and rise again based on just one chart. But based on the macroeconomic situation at that time and now, Viet Hustler completely disagrees.

• The current inflation cycle is unlikely to turn into a prolonged stagflation cycle unless there is a huge shock to the economy like Covid…

• Leading indicators of inflation in the housing and consumer markets all indicate that inflation is on a downward trend along with reduced consumer spending demand.

• In addition, the Fed is still under great pressure from the possibility of economic recession if consumption collapses and adverse developments in the bond market.

Finally, Viet Hustler believes that although the Fed may not raise rates “higher”, it will keep the current rate level for a sufficiently long period (“for longer”) to monitor economic data and ensure inflation returns to the 2% target.