Powell Likely To Give Markets Some Relief At Jackson Hole

Every August, the Fed’s Jackson Hole summit is hosted by the Kansas City Fed. The event’s history is deeply intertwined with the Fed’s past and current efforts to vanquish inflation. As long-term rates have risen over the past few weeks, technology stocks in the Nasdaq (QQQ) have suffered. However, I suspect Powell’s tone at Jackson Hole will support the index. Furthermore, I suspect US long-term rates are at or near their peak, which will relieve the QQQs.

The first time the Jackson Hole Summit was held in 1982 was immediately after Chairman Volcker had taken the most aggressive and (at the time) controversial actions in the Fed’s modern history to break the back of inflation. There’s a theme every year, and this year’s theme is “Structural Shifts in the Global Economy.” This theme is a hint that the Fed will argue that much of the inflation was caused by extraordinary events rather than monetary or fiscal policy.

The initial 1982 summit had been planned shrewdly by Kansas City Fed President Roger Guffey to be a destination known for fly fishing, a favorite hobby of then Chairman Volcker. One of the distinguishing features of fly fishing is understanding the psychology of the fish or doing what’s known as reading the water.

While inflation was near a multi-decade peak last year as Powell brought out the belt, when you exclude Shelter, we’re much closer to the Fed’s target than grumbling from bears hanging their hat on Milton Friedman-inspired syllogisms would suggest. Recent indications suggest the Shelter component will fall faster than consensus expects.

Thus, last year’s symbolic water was very different than this year’s, and I think there’s a setup here for the market to resume its upward push after a healthy sell-off and consolidation. I think there are several reasons why Chairman Powell will give some bullish relief in his comments.

• Broad progress on inflation over the last year and two successive positive CPI reports have given the Fed less need to hike further, at least in the short term.
• Labor markets have been behaving consistently with the soft-landing thesis, and there’s increasing consensus a recession is not imminent.
• Economic weakness in China means downward pressure on inflation is more likely to be sustainable.
• Economic strength in the United States is increasing, with the recent Atlanta Fed GDP Tracker suggesting GDP growth of 5.8%.
• Recent rises in rates coupled with mounting hedge fund bearishness on long-term rates have raised US borrowing costs to record levels.
• This, coupled with mounting pressures on US banks, means that the Fed would like “higher for longer” to last long enough to vanquish inflation, but certainly no longer than necessary.

This effectively puts an upward limit on rates, despite a need for tough talk, and makes me even more confident that the rate hiking cycle is over. While Powell and friends will surely give some lip service to inflation, the recent CPI reports suggested that CPI can continue its downward trend.

I was greatly encouraged by Philadelphia Fed President Harker’s recent comments that suggested the Fed hiking cycle was over and that cuts also could come sooner than the consensus currently expects.

Powell Likely Treads Lightly and Touts Progress on Inflation

The Fed’s Jackson Hole summit is the Fed watcher’s summer block party, and it’s even more consequential at the end of the most aggressive hiking cycle since Paul Volcker, the man whose love of flyfishing is responsible for the genesis of the summit, walked the halls of the Eckles building.

And the bears appear ready for a party given that there has been what seemed to be a “bear steepening” in the US curve. But this gives Powell a perfect opening to focus on progress in the inflation fight and to set the market’s sights on cuts in 24 rather than adding to current fears, which could evolve into financial stability concerns.

But if Powell brings honey instead of vinegar, the result would likely be some normalization of the busted-up curve. This is important for maintaining financial stability and relieving embattled regional banks. While some investors may be worried about economic weakness in China, rather than financial contagion being exported to our side of the Pacific, I’d guess low prices will be what’s on the way. This gives the Fed cover to project optimism.

Last year, the market enjoyed a summer rally that undid financial conditions to a degree unacceptable to a Fed in the early stages of its hiking cycle. And recent economic strength might normally tempt Powell to put the focus back on how big a threat inflation remains, but financial conditions have tightened considerably into Jackson Hole this year, despite projections for white-hot economic growth from the Atlanta Fed.

Of course, that led to Powell admonishing the markets and talking down the rally in furtherance of his mandate last year. This year, I think it will be the approximate opposite. Many market bears, frustrated by the year’s prolific rally in stocks, have been greatly encouraged by the last three weeks of consecutive market losses. Still, I strongly suspect this year’s Jackson Hole meeting will be approximately the inverse of last year, giving markets more reason to continue their postponed rally.

I have covered this extraordinary Fed hiking cycle extensively:

• Before Silicon Valley Bank’s collapse, I postulated that the Fed was calling the bond market’s bluff that it would “break something” and that they had a better grip on financial stability than consensus afforded.
• After the last Fed meeting, I stated that I believed the Fed would hike zero times or only one more time (one and done). That’s now the consensus view, but it was not then.
• I predicted there was potential for diminished volatility following the last jobs report after the sell-off caused by the ADP report. I got people into the Dow before its recent 13-day streak.
• Now, I’m confirming that notion. I believe this next hike will be the last in a gauntlet of a hiking cycle. A majority of economists now agree with this take.
• Positive economic data are increasingly validating the possibility of a soft landing. Inflation is coming down convincingly, as the July CPI report validated.

There could certainly be some weakness between now and the Fed’s press conference on Friday. However, I think this latest period of market weakness will end in short order. And I think Powell’s comments at Jackson Hole may be a primary catalyst in turning markets around.

Risks and Where I Could Be Wrong

There have been a lot of reasons for mounting negativity in August, and of course, all of these are likely exacerbated by low volume and much of Wall Street likely soaking up the rays instead of glued to their Bloombergs. And indeed, August is generally a risky month from a seasonal perspective. While the current inflationary drivers seem to be under control, we’re also in an agitated geopolitical environment that could quickly lead to that reversing.

War, in particular, has been a historical driver of inflation, not just when the war is being fought but also in its aftermath. Thus, one of the primary risks to the Fed in its hiking cycle is if the Russia-Ukraine War or other geopolitical hot spots lead to further supply chain disruptions and trade barriers that reignite diminishing inflationary pressure or result in a market panic that takes the focus off inflation altogether.

• Escalation in Ukraine or Taiwan
• Fed Policy Error
• Banking Issues Worsen
• US fiscal issues or political division
• CRE meltdown
• Chinese Real Estate/Debt issue contagion

Other than this, any shock to the global energy complex that spikes prices is probably the primary risk that the Fed will have to continue hiking or potentially that a policy error has occurred. Of course, several other significant risks could derail the market’s progress, even if the Fed comes out with a conciliatory tone.

Two days before the Fed’s press conference is Nvidia’s (NVDA) earnings report. Last quarter, this propelled the whole market into a major rally. Disappointment in the report could result in the opposite this time. If CRE’s weakness blows up, it could be a double-whammy that could simultaneously speed up the slow-motion banking problems.

Conclusion: The Doves Are Back in Town

The meeting minutes from the Fed’s last meeting were treated mainly as a bearish development since Fed members seemed keenly focused on potential upside risks to inflation. However, if you read between the lines, it’s also clear the dovish elements of the FOMC are becoming more empowered by economic data that increasingly vindicates their philosophy at the expense of monetarists and inflation hawks.

While war is historically a powerful driver of inflation, the opposite is found in the aftermath of pandemics. Since the pandemic had a much more ubiquitous effect on the global economy than the War in Ukraine has, I think it’s possible that normalization from COVID is the single most significant force on inflationary pressure and that inflation’s decline will be sustainable. The recent near-record outflow in long-term US bonds also convinced me we are near a shift toward more positive sentiment.

If long-term rates can retreat and halt their march higher, then I suspect the Nasdaq will not only reverse its recent losses but will march forward to new local highs. I’m increasingly confident that the Fed’s hiking cycle is over. I believe they will provide insight to suggest this at Jackson Hole while remaining guarded. Mounting US debt service also puts a de-facto cap on how long “higher for longer” can last.

While the minutes show lingering concerns about inflation, they also show that the doves are increasingly empowered and more aware of the unnecessary damage that overly restrictive policy could inflict on the US economy-the minutes occurred before the July CPI report when June’s positive reading could have been an anomaly. The data has favored the doves these past three months, and I think they’ll make themselves more apparent at Jackson Hole than they have since the beginning of this fateful hiking cycle.