Will Jay Powell provide more clarity on policy?
Investors in stocks, bonds, and currencies are eagerly awaiting the Jackson Hole event. The summit, which was initially set to span three days in-person, is now be shortened to a one virtual day because of rising coronavirus concerns. However, from markets perspective, it's the Fed Chair, Jerome Powell who is set to speak Friday at 2:00 pm GMT is all that matters.
Tomorrow’s summit is occurring at unusual times, where the virus continues to disrupt supply chains, inflationary pressures building up, and the V-shaped economic recovery is expected to slow down in the months ahead. The conundrum central banks are currently facing is what to do in lower growth, but high inflationary environment? The virus trajectory remains unknown, and that brings a lot of uncertainty. No one knows with significant degree of accuracy the longer-term growth outlook, and the structural shifts that will occur in a few quarters from now.
The latest US employment report suggests considerable improvement in the labour market. Around 2.5 million jobs were added in the past three months, unemployment dropped 0.7% for the same period, and wage growth have steadily increased by 0.4%. Looking at these metrics, the Federal Reserve seems on the right trajectory for achieving the employment mandate. However, inflationary pressures remain elevated in the world’s largest economy and despite slowing down slightly in July consumer prices remained above 5%, indicating that the price stability mandate could have already been met.
What is not a mandate but one of crucial importance to monetary policy officials is stability in financial markets. The Fed cannot keep policy loose forever, but the action to tighten needs to be careful and not lead to chaos in equities and bonds.
The fate of the $120 billion monthly purchases by the Federal Reserve is what investors needs to know about when Powell speaks tomorrow. They may get some hints, or maybe not.
If Powell signals that current economic conditions are in favour to begin pulling back from the unconventional policies pursued during the pandemic, that will likely drag equities from their record highs and provide a little lift to bond yields which supports the US dollar. That doesn’t necessarily mean the end of the bull market, but more of a pause. The direction of equities will then depend on macro-data, earnings projections, and overall sentiment.
The longer Powell waits to announce the end of the Fed’s unconventional measures, the greater the risk of a policy mistake in the future, which would bring more volatility and possibly huge selloffs in stocks and bonds in the months ahead.