All eyes are set on the annual Economic Policy Symposium in Jackson Hole, Wyoming, starting on August 26, 2021. The two-day event, hosted by The Federal Reserve Bank of Kansas City, will be a modified in-person program this year, attended by global central bankers, finance ministers, economists, and financial market participants. Before delving into the meeting, let us set the stage.
The US Fed had cut short-term interest rates to near-zero levels in March 2020 and restarted its large-scale asset purchase program. Since July 2020, the central bank has been buying $40 billion of agency mortgage-backed securities and $80 billion of Treasury securities each month to support the Committee’s “maximum employment and price stability goals.” Since the US economy rebounded in mid-2021, officials have been hinting at tapering these bond purchases. In June 2021, Chairman Powell acknowledged that the bank is assessing the composition and pace of its asset purchases since the economy has been moving toward the Fed’s macroeconomic goals. The US economy added 943K jobs in July 2021, the highest in 11 months, as rapid vaccinations drove higher business re-openings. The unemployment rate also dipped to its lowest level since March 2020, at 5.4%. On the other hand, inflationary pressures have been hounding the markets for some time. In July 2021, consumer price inflation remained unchanged from June’s 13-year high, at 5.3%. The combination of these factors leads many market participants to believe that the economy is nearing a place where monetary accommodation can be removed, which brings us back to Jackson Hole.
The Jackson Hole Symposium is one of the most anticipated events in the financial markets calendar and is often the cause of a volatility surge in its aftermath. For instance, last year at the 2020 symposium, the US Fed had made the historic announcement of a shift in its monetary policy framework, which had rattled the global markets. The Fed Chairman, Jerome Powell, laid the central bank’s foundations to tolerate inflation above the 2% target. This essentially meant the continuation of monetary policy support for longer than previously discounted. As a result, US stocks rallied through the event, while other global stocks ceded gains, and the dollar fell.
This year, it is quite possible we could have the inverse of the 2020 moves. After the last FOMC minutes on August 19th, markets have largely discounted a tightening liquidity environment because of the FOMC’s seemingly general consensus that a taper of asset purchases is possible by the end of 2021. As we highlighted from the last FOMC minutes:
“Participants expressed a range of views on the appropriate pace of tapering asset purchases once economic conditions satisfied the criterion laid out in the Committee’s guidance. Many participants saw potential benefits in a pace of tapering that would end net asset purchases before the conditions currently specified in the Committee’s forward guidance on the federal funds rate were likely to be met. At the same time, participants indicated that the standards for raising the target range for the federal funds rate were distinct from those associated with tapering asset purchases and remarked that the timing of those actions would depend on the course of the economy. Several participants noted that an earlier start to tapering could be accompanied by more gradual reductions in the purchase pace and that such a combination could mitigate the risk of an excessive tightening in financial conditions in response to a tapering announcement. “
To us, the above tells us two things. The first is that the full-employment and price stability goals don’t need to be met for the Fed to move its balance sheet policy; they simply need to make “substantial further progress,” which is a purposely ambiguous term. The second is that the Fed could consider tapering sooner rather than later to have a much more gradual taper process. Overall, a taper is very much in the cards for 2021, with significant potential for September as the announcement date. As we have said before, and we shall say again today, we think that high-quality US stocks are likely to be the best hiding place during a time of US liquidity withdrawal. We, therefore, continue to think of it as an optimal exposure given fundamental and market dynamics.
However, we think the removal of policy liquidity by the Fed (or its communication) will be considered a net negative for asset prices (and US stocks). Therefore, we think that there is significant potential for Jackson Hole to be a hawkish event that bids up the dollar, a move that markets seem to be sniffing out over the last month. Overall, the optimal approach going into the event is likely to be to protect US stock exposure and wait for the signal from the Fed. Either way, we think the environment will be conducive to US stocks vs. the RoW stocks, so we should really only be concerned with managing event risk here.