Jackson Hole Dominates!
Author: Tom McGrath – Chief Investment Officer, 8AM Global
Market Review
For most of last week, investors held their breath, waiting for J Powell to deliver his economic update at the conclusion of the Jackson Hole Symposium on Friday. They liked what they heard, and in the final hours of a busy week, US equity markets rallied higher into the close, dragging averages up there and in Europe. Fixed-income investors shared their relief, and yields finished the week lower. Gold hovered around an all-time high, and oil drifted lower because there was no new escalation in the Middle East, and the Dollar trended lower against major currencies. The standout movement came from US Small Cap, with the Russell 2000 bouncing more than 3% on Friday as Powell paved the way for rate cuts, a perceived positive for smaller companies.
Jackson Hole
The Jackson Hole Economic Symposium is an annual event sponsored by the Federal Reserve Bank of Kansas City since 1978 and held in Jackson Hole, Wyoming since 1981. Every year, the symposium focuses on critical economic issues that face world economies, but naturally, it is very US-centric with the Fed Chairman J Powell holding court. Participants include prominent central bankers, finance ministers, academic luminaries, and leading financial market players worldwide. This year, we were waiting for the Fed to finally confirm that they were ready to start cutting interest rates, and investors were not disappointed.
Powell confirmed what was widely anticipated; that the Fed is set to cut interest rates in September. He stated, “The time has come for policy to adjust. The direction is clear, but the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks”. Powell also signalled the possibility of a more assertive approach to normalising interest rates, noting that the current fed funds rate provides “ample room” to address future risks.
Additionally, he did not challenge market expectations of nearly 100 basis points in rate cuts by year-end. Both equity and bond markets headed higher, more out of relief than euphoria.
If you remember, unlike the BoE and ECB, the Fed has a more specific dual mandate to tackle inflation and ensure steady employment. Inflation is now taking a backseat to the labour market. The August employment report will determine whether the Fed cuts by 25bps or 50bps in September. My main takeaway from Powell’s speech is that the Fed will not tolerate further weakness in the jobs market and will likely start things off with a 25bp rate cut in September.
The speech and recent economic data still befit the ‘soft landing’ scenario we have all been hoping for, and it explains why the equity markets have just about made up all the ground lost at the start of August. It would seem that bond investors have become even more optimistic about the pace of rate cuts as the US 10-year Treasury yield is now looking as if it will finish the month around where it started the year, a time at which consensus was suggesting that the US economy would fall into recession in 2024. That indicates to me that the ‘froth’ in the financial markets is more likely to be found in fixed income rather than in equities, as I still maintain a view that the economy is a little more resilient than consensus would have us believe – no bad thing for share prices – but it could lead to yields backing up when rate cuts don’t come as fast as bond investors would like.
However, we got a downward revision to US job growth in the year through March. According to the Bureau of Labor Statistics’ preliminary benchmark revision, the number of workers on payrolls is expected to be reduced by 818,000 for the 12 months through March, averaging about 68,000 fewer jobs per month. While economists had generally anticipated a decline, some projected a reduction of up to 1 million jobs, so it didn’t come as a shock. Remember, this is backward-looking data. In fact, despite the revisions, the economy has created many new jobs (170,000 a month!), and trend job growth is still strong, but not enough to keep up with growth in the working-age population, where we are seeing a big return to work. It also largely ignores the rise in the immigrant workforce who are less likely to show up in official figures.
Adding weight to our ‘stronger for longer’ assumption for the US economy came the latest flash PMI data, which indicated a healthy expansion, especially outside of manufacturing. There was also good news from the housing sector, where existing home sales came in stronger than expected. All in all, I think the Fed has to be happy with the current economic position.
UK
Bank of England Governor Andrew Bailey also got to speak at Jackson Hole, where he expressed cautious optimism about inflation but warned it’s too early to declare victory after a period of high prices. Remember, the BoE has already cut interest rates this month for the first time in four years, lowering from 5.25% to 5%. They too must be pleased with the progress over the last year; it wasn’t that long ago (Oct 23) when inflation registered at 11.1%, but it has since come down to 2.2% in July of this year. The good news doesn’t end there; the UK economy has surprised to the upside, and it is still extraordinary to think that for the first half of the year, we had the highest GDP growth in the G7!
Growth seems set to continue as the latest PMI data released last week suggested the economy remains in good health with an overall reading being more positive than expected and comfortably in expansionary territory (above 50). Services continue to lead the way but manufacturing is also clawing back to near 50. That means the BoE will be in no rush to cut rates for at least the next couple of months. Again, if they do, it will probably occur when they get to accompany the cut with a formal statement and press conference, with the next quarterly one scheduled for November.
Europe
In August, the Eurozone’s economy showed improvement, as the overall PMI rose to 51.2 from 50.2 in July, suggesting slight growth. But before we get too excited, that looks to be driven by a one-off factor, largely thanks to a surge in France’s service sector due to the excellent hosting of the Olympics. Digging deeper, manufacturing across the Eurozone continued to struggle, especially in Germany, where activity dropped sharply, which probably means that the ECB will soon be open to another cut in rates.
Europe has been our biggest underweight in portfolios all year, and we worry that the combination of a very inflexible labour market, and regulatory barriers to innovation, creates a wide gap between productivity growth in the US and the Eurozone. With downward US payroll revisions, it actually implies an increase in US nonfarm productivity, probably now around 3.4% y/y in Q1 rather than 2.9%. In contrast, Eurozone productivity growth has been negative for several quarters.
Japan
From the lone cutters to the lone G7 hiker, it now looks like the Bank of Japan will likely raise interest rates again this year, possibly in October, based on its hawkish signals from the July meeting. The BoJ’s July statement mentioned that they’ll keep adjusting rates as long as the economy stays on track. It also highlighted that real interest rates are still low and won’t soon hit the neutral rate range.
This should not disrupt the economy’s inflation process, mainly since Japan’s ageing population has led to higher household savings, and the Yen’s recent recovery should help cushion the impact on spending. Additionally, years of debt reduction have made businesses less sensitive to rate increases. They will tread carefully though; the August financial market instability led to criticism that the BoJ was moving too quickly. If market instability returns, the BoJ might be more cautious about hiking rates again. Political factors could also influence the BoJ’s decisions, depending on who replaces Prime Minister Fumio Kishida in September. While the Yen’s weakness has eased for now, there’s concern that politicians might worry more about potential stock market drops and the impact on vulnerable groups like low-income households and small businesses.
This Week…
Nvidia results will be out on Wednesday night and may overshadow any macro updates next week. Their investors will look for signs that the demand for Nvidia chips is spreading from the Big Tech giants into mainstream companies. Nevertheless, several important releases this coming week will provide the first insights into the economy’s performance in August. We will likely see continued labour market strength reflected in the consumer confidence survey (Tuesday) and initial unemployment claims (Thursday). Some of the improvement in August could be attributed to a rebound from July’s weather-related slowdown, which might also be evident in July’s personal income data (Friday). Consumer spending for July (Friday) could be pleasantly surprising, similar to the solid retail sales report. Finally, July’s PCE inflation rate (Friday) is expected to align with the Fed’s dovish outlook without causing major concerns.
Outside of the US, we get the Eurozone Inflation Rate (Friday), which investors will closely watch, especially given the ECB’s recent actions and the ongoing economic challenges in the region; any uptick will lessen the chance of an imminent rate cut. We get China Manufacturing PMI (Saturday), which will offer insights into the health of China’s manufacturing sector; any signs of faltering may bring further action from the PBOC. And Japan’s Unemployment Rate (Thursday) data will be significant for the BoJ in deciding on rate moves.
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