Carmignac: Outlook for Jackson Hole

August 19, 2022

This is a commentary by Kevin Thozet, member of Carmignac's Investment Committee, looking ahead to the upcoming Jackson Hole Economic Symposium, taking place August 25-27.

The 2021 Jackson Hole Economic Symposium saw central bankers, and notably J. Powell, emphasising the transitory nature of inflation and hence sticking to strict, dovish, forward guidance. Since then, they have dropped the latter, hiked rates to a level closer to neutral and became far more data-dependent in the face of persistent price rises.

How things have changed in a year

For investors, the lack of forward guidance means the communication and strategy of central banks has taken a back seat to following the latest data releases to ‘pre-empt’ policymakers’ next move. The most recent publications have been strong (US employment data on 5 August showing more than 500K jobs created in July and US retail sales for the month were above expectations, confirming the strong economic starting point).

Meanwhile, inflation - both realised and expected - in the immediate months ahead remains too high and far above the Fed’s target. However, the market perceived Powell’s tone during the July FOMC meeting to imply a slowing of the pace of interest rate hikes from September onward, triggering a rise in equity prices and easing of financial conditions. Bond markets expect a U-turn of the Fed from Q1 2023.

This is a tough balancing act for the policymakers at Jackson Hole. Powell likely wants to signal that the Fed is not done with the tightening cycle, but the market perceives a slowing of the pace of increases to be the beginning of the Fed moving away from tightening altogether. He will probably aim for a message of “slower for longer”. However, risks remain that markets will ease financial conditions further if they focus to a greater extent on the first part of that message, causing more pain down the line when the “longer” part plays out.

Focus on the framework 

The area where we might see some further detail could be related to the framework in which the Federal Reserve operates – after all, the symposium is intended for academics and to address long-term issues.

Inspired by the current economic picture, the interpretation of ‘neutral rates’ could be explored so that the level of interest rates considered neither accommodative nor restrictive could be nuanced to adjust to changes in financial conditions or because of a high inflation backdrop. Indeed the 2.5% theoretical neutral rate level assumes 2% long-term inflation; with US inflation at 8% or so, neutrality is likely above 2.5%. As such, Jackson Hole could provide the opportunity for J. Powell to outline the market’s complacency in placing terminal rates so low and expecting such a sudden shift in monetary policy stance. And that a potential slower (yet longer) tightening cycle does not signal the green light for softer financial conditions.

We could also be provided with some more elements on the euro area monetary policy. Indeed, the upcoming European Central Bank (ECB) meeting will be held on 8 September. And, factoring in the “quiet period” of seven days, means that the Jackson Hole Symposium could provide a public platform to further prepare market participants for its (expected) second hike in 10 years (anticipated to be 50 bps in September).

Implications for fixed income markets

In our view:

• US short-term interest rates will move higher as markets have been pricing recession risk sooner rather than later. We don’t expect a recession to hit the US until the second part of 2023; and irrespective of such a view, the US recession is largely expected to be fed by higher interest rates. The Fed’s focus on lagging indicators (mainly inflation and labour markets) means that it will be late to eventually turn -- which implies a flattening of the US yield curve (more now = less later).
• We also expect the ECB to lean on the hawkish side, with inflation not expected to peak in the eurozone before this autumn and risk-on prices being tilted on the upside (the ECB’s own gas cut-off scenario integrates more hikes down the road – even more likely as such a dramatic event would mean more fiscal support).