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There were no surprises on the first day of the Kansas City Fed’s Annual Jackson Hole Forum. Fed officials stuck to the script laid out at the July FOMC meeting. Many expect Fed Chair Jerome Powell to do the same today. Better US data lifted the Dow, S&P 500 and Nasdaq Composite by 1%, 1.4% and 1.7% respectively. The US Treasury 10Y yield eased 7.8 bps to 3.026%; 2Y fell 2.5 bps to 3.366%. The futures market expects the Fed Funds Rate to peak at 3.50% this year into 2023. DXY is fluctuating between 108 and 109, at the top of the 105-109 range set in July. We remain mindful that the USD’s surge in March-July stemmed from the Fed Funds Rate catching up to bond yields. As things stand, it defeats the purpose for the Fed to hike by 75 bps next month only to have bond yields below the policy rate.
First, US inflation is too high for Fed to ease off the brakes. Today, Bloomberg consensus expects the US PCE deflator to decline to 6.4% YoY in July from 6.8% in June, and the core deflator to 4.7% from 4.8%. Although CPI inflation eased earlier to 8.5% YoY from 9.1% for the comparable period, Fed President James Bullard (St Louis) was concerned about inflation staying high for longer. Before the forum, Neel Kashkari (Minneapolis) was also worried about inflation becoming persistent.
Second, the Fed wants rates to be restrictive above the estimated 2-3% neutral range this year. Most agree with the Fed’s Summary of Economic Projections for rates to end around 3.4% this year and 3.8% next year. Hawks like Bullard wants to frontload hikes to 3.75-4% this year. Esther George (Kansas City) wants rates to keep rising until there is evidence that inflation is falling. She did not rule out a terminal rate above 4%. On 23 August, Kashkari signalled rates could rise another 200 bps above the present 2.5% by the end of 2023 to anchor inflation expectations. Patrick Harker (Philadelphia) reckoned rates could rise above 3.4% before the Fed pauses to assess the impact of the hikes.
Third, the Fed could hike by 50 bps or 75 bps on 21 September, depending on the incoming US data. Harker considered 50 bps a substantial move. Markets will pay close attention to two sets of data. The first will be the US monthly jobs report on 2 September. Consensus expects nonfarm payrolls to slow to 300k in August after the surprise jump to 528k in July. US initial jobless claims fell more-than-expected to 243k (vs 252k consensus) for the 20 August week from 245k (revised from 250k) the previous week. The decline in continuing claims to 1415k from 1434k suggests that the unemployment rate will stay low at 3.5%. The second will be the US CPI data on 13 September, the key data that preceded the past two 75 bps hikes.
Fourth, the Fed hopes to achieve a soft landing while controlling inflation. Yesterday, the Bureau of Economic Analysis revised 2Q22 GDP growth to an annualized -0.6% QoQ saar from its advance estimate of -0.9%. Harker did not see a high risk of a sustained deep recession. Interestingly, Bullard did not have a clear outlook for 2023, acknowledging that recession risks accompany the frontloading rate hikes. On 19 August, Thomas Barkin (Richmond) also admitted a recession could happen to get inflation under control.
Quote of the day
“There is a safe spot within every tornado. My job is to find it.”
David Copperfield
26 August in history
Harry Houdini escaped from chains underwater in 57 seconds, at Aquatic Park in San Francisco, California in 1907.
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