The annual gathering of central bank leaders at the Jackson Hole symposium in Wyoming on Friday will firmly place Federal Reserve chair Jay Powell in the spotlight for investors. While he faces the unusual problem of a president voicing criticism of interest rate policy, Mr Powell has a strong US economy and relatively becalmed markets in his favour.
What will be Mr Powell’s principal message?
Investors have been distracted of late given the implosion of the Turkish lira, pressures on emerging markets, US sanctions, ongoing trade tensions, a presidential broadside at the Fed for raising rates and the rising stakes of November’s midterm elections.
But for Mr Powell, not much has changed. The US economy remains well placed. The Atlanta Fed estimates real GDP growth is running at 4.3 per cent for the third quarter, wage pressures are rising, inflation is on target and unemployment is below 4 per cent. Add to that a new record level for the S&P 500, plus a further injection of fiscal stimulus in the second half, and Mr Powell would argue that conditions justify the further tightening of policy at a steady clip.
Gregory Perdon, co-chief investment officer at Arbuthnot Latham, said Mr Powell “will probably try to signal a level of cautious optimism”.
Will Mr Powell defend the Fed’s independence in the wake of Donald Trump’s criticism?
At some point, he will be asked about it. Markets will be mindful of any sign that the Fed “could be influenced by the president”, said Sandra Crowl, investment committee member at the European fund manager Carmignac. The dollar weakened following Mr Trump’s interest rate remarks in a Reuters interview earlier this week.
But Mr Powell will strenuously avoid being drawn into what Mr Perdon called “a public bickering” with the president.
Mr Trump’s aversion to higher interest rates is well known, but as forex analyst Kit Juckes at Société Générale said, “he can’t do much about it”.
What impact will the strong dollar have on Mr Powell’s Jackson Hole speech?
The strong dollar may be a preoccupation of Mr Trump, who in addition to criticising the Fed, is turning up the rhetoric on China and Europe for currency weakness. But the Fed has no remit to take account of the dollar’s value. Besides, while the dollar has reversed course this year, to the surprise of investors, it is arguable whether it is truly dominating the foreign exchange market.
And with this week’s verbal jawboning and the Mueller investigation developments, the dollar’s resilience is being tested.
“It’s not like the dollar index is going crazy,” said Paul Lambert, currency manager at Insight Investment. “The S&P 500 still seems to be able to remain firm with these dollar levels.”
But Simon Derrick at BNY Mellon said the Fed will be “mindful of any competitive pressure on US companies from the dollar’s strength”. The evidence of such pressure may be sparse, but “a lot can happen between the September and December Fed meetings”, Mr Derrick added.
Will Mr Powell pay heed to the Turkish crisis and wider concerns in emerging markets?
Mr Powell, like the markets, will be inclined to view Turkey’s problems as “idiosyncratic”, said Stephen Gallo, forex analyst at Bank of Montreal. “Global fundamentals still look OK.”
Analysts believe that any reference from Mr Powell to international issues may amount to no more than lip service. While the dovish former Fed chair Janet Yellen was more inclined to worry about the potential impact of a slowing global economy on the US, analysts and investors think Mr Powell is less concerned.
“Powell is in a different place to his predecessor, because the US economy is considerably stronger than it was under Yellen,” said Mr Derrick. “It doesn’t matter too much whether the economy is being powered by organic growth or by stimulus, nor should the problems of other economies exercise Powell unduly.”
By reducing its balance sheet, the Fed has exposed those EM economies that are dependent on dollar funding to the perils of reduced liquidity. Uncertainty prevails when central bank funding of EMs slows, said Mr Lambert. “When the worm turns, investors ask, ‘where is value?’” he added.
A rate rise in September looks nailed on, but then what?
Ignoring external factors, Mr Powell will be focused on “anchoring the Fed’s interest rate path according to the economic environment”, said Ms Crowl. And that path envisages a further two 25 basis point rate rises this year - the first of which is priced in for September but only partially for December - and possibly three in 2019. In an ageing business cycle and an environment of wage pressure, rising inflation and reduced output gaps, “he has good reason to raise rates”, Ms Crowl added.
While a more active Fed has driven short-dated market yields sharply this year, the shift also reflects hefty sales of Treasury bills to help finance a growing US budget deficit in the wake of the Trump administration’s tax cuts. Meanwhile, the 10-year Treasury yield remains well below 3 per cent, and this important benchmark influences the cost of US home loans and longer term company borrowing.
Markets fret about trade tariffs and their potential impact on global growth, but Mr Perdon is inclined to view them as tools of negotiation rather than a long-term problem for the global economy.
He said it was “too soon to get worried” about the US economy.
– Copyright The Financial Times Limited 2018
