TL; DR

This year's Jackson Hole Economic Symposium, themed "Structural Shifts in the Global Economy," will focus on the evolving challenges in monetary policy amidst a complex economic backdrop. A key topic will be the Federal Reserve's (the Fed) approach to managing interest rates and its balance sheet, particularly given persistent inflation, recent liquidity injections by the Treasury, and the potential implications of a not so soft landing. Market participants will be keenly watching for unscripted moments and informal discussions to gauge the Fed and Treasury’s stance on liquidity, particularly as global uncertainties like the yen carry trade unwind continue to pose risks to the global collateral base, and financial stability.

What a difference one year makes - welcome to your Jackson Hole 2024 primer!

Jackson Hole kicks off in a week—here‘s why it matters

Yeeha - it’s on again. It’s the annual Woodstock for bankers where the Federal Reserve Bank of Kansas City welcomes a squadron of the world’s most senior central bankers, economists and thought leaders to prognosticate on economics in the cool shadows of the impressive Grand Tetons, pictured above.

It’s referred to simply as ‘Jackson Hole’, short for the Jackson Hole Economic Symposium.

This year’s topic is: “Reassessing the Effectiveness and Transmission of Monetary Policy.”

The agenda is not normally sent out until the first day. Many will be eager to hear if Fed Chair Powell will outline when, if, and how he might slow or shift the tightening pace.

But that’s probably not going to happen.

Typically, the Fed Chair makes some opening remarks on the first day and that’s followed by a couple of days of paper presentations and (mostly) interesting panel discussions.

The more informative part of Jackson Hole is what happens between the formal proceedings and during the outdoor breakout press interviews. These are unscripted.

And we know from past press conferences that unscripted responses to the press is not Chair Powell’s strong suit.

Investors will likely be watching those informal interludes for clues to judge the size of September’s rate cut, or whether the Fed will continue on pause as well as Powell’s forward trajectory for monetary intervention.

While we can remain hopeful for some theatre, here’s a refresher on where things are at so you can tell whether what falls out of the Fed’s saddle bag is something, or nothing.

The economic backdrop to this year’s symposium

Inflation, interest rates, dollar

• Inflation is still above the Fed’s 2% target range.

• Despite higher interest rates for longer, U.S. commercial real estate has so far not blown up.

• We have not yet seen a repeat of the Silicon Valley Bank failure.

• As the rate cycle nears its end, the Fed has slowed tightening, while the Treasury has added around $500 billion in new liquidity to the markets since the last Jackson Hole symposium.

• The federal funds rate (FFR) currently sits at 5.25% to 5.5% and the market feels that several rate cuts are coming. Whereas a year ago just before Jackson Hole, the dot plot indicated that some Fed Governors felt that taking the FFR to around 6% might be needed. But we didn’t quite get there.

• The USD is still strong against most currencies with the DXY trading at 103, trading around its December 2016 and March 2020 pre-COVID peaks, which is around 5% below the COVID lockdown peak which completed in October 2022. This high Dollar Vader is keeping a ceiling on emerging market and industrial metals growth.

• With CPI down a lot, and PPI still strong, there was nothing (until recently) to suggest that the Fed might cut rates given there’s still the risk that inflation could come back if the Fed loosens too soon.

Unemployment ticks up and triggers Sahm Rule

• However, a tick up in the U.S. unemployment rate in July triggered a breach of the Sahm Rule, which is rule created by macroeconomist Claudia Sahm, and which posits that where the three-month average of the unemployment rate is ½ percentage point (0.50%) or more above its low over the prior twelve months, then the US is in the early months of a recession. As per below 📈👇 the rule was triggered, adding fear and uncertainty to markets. The fear and greed index (the VIX) went parabolic and last week hitting a contextually whopping 65.73 print.

Dollar yen and carry trade unwind

• At the same time, we witnessed a partial unravelling of the dollar yen trade - following a surprise increase in Japanese interest rates by the Bank of Japan (BOJ) plus forward guidance on additional rate increases. This made the carry trade (i.e., borrow in low yielding yen and invest in higher yielding U.S. Treasuries and AI/Mag 7 stocks) less viable than before the announcement.

• This should remind us of the level of leverage in the system, and potential for a small ‘relative’ change to potentially burst a major pipe in the global plumbing. Multiple trillions are at play when economies seek to usher in a major regime change.

• BOJ’s Uchida subsequently came out last week to say that the BOJ would not increase interest rates during times of market instability. Rather, the bank said it would stick with current policy. Some investment banks feel that the carry trade unwind is possibly only half-way over.

• No one knows how big any trade unwind contagion will be. Will the effects be savage enough to cause central banks to pivot to wholesale interest rate cuts? Is this what we’ve been waiting for to justify a pivot of the magnitude of a few hundred basis points cut, which has been factored into markets for many months already?

Liquidity, the key driver of risk markets

• The Fed's balance sheet is now $7.175 trillion, down nearly $1 trillion from last year and $1.7 trillion below its $8.9 trillion peak.

• While QT (quantitative tightening) is still technically in progress, it’s important to note that its impact has been offset by significant liquidity injections from the Treasury. They’re working together and instead of tightening; the overall effect has been more akin to easing. You can get a refresher by reading my Treasury is Fed, Fed is Treasury (TIFFIT) series.

• Specifically, although the Fed has succeeded in withdrawing just under $1 trillion from its balance sheet (while leaving the federal funds rate at 525-550 basis points), Treasury has introduced $1,479 trillion of liquidity into the economy/markets.

• Since the last Jackson Hole, we’ve seen the Treasury and Fed team up to produce stealth liquidity, or a net injection of $479 billion into markets - which is easing, not tightening - and it’s why I continue to remind you all that the QE Infinity Train to Nowhere, somewhere off the cost of Japan, never stopped, it just keeps chugging along under new acronyms……

• So far, Treasury auctions have been well supported with short duration covered more than 3x and mid to long term covered around 2.7x. So far, no plumbing problems to see there.

That’s pretty much the backdrop going into Jackson Hole.

The big driver and question is not about rates, it’s about liquidity

As we approach Jackson Hole 2024, the main focus isn't just on interest rates—it's on liquidity. With the Fed and Treasury's collaborative actions blurring the lines between tightening and easing, the market's expectations are set on whether the Fed will pivot and how it will navigate the complex global landscape.

Will Powell signal a major shift, or will we continue in this precarious balance? As always, the unscripted moments may reveal more than the official agenda. Stay tuned, saddle up, and watch for those crucial off-the-cuff remarks that could steer the market's next move.

Mike