Momentum is Green… But. The energy sector largely held this market together on Tuesday. Based on bond market action, the focus is the Federal Reserve’s Jackson Hole symposium that starts later this week. Low volume and late-summer vacation create difficult trading environments. However, it feels like this market is very close to turning in the wrong direction.
This week, the Federal Reserve hosts its annual Jackson Hole Symposium. Well… hold on. It’s technically hosted by the Kansas City branch of the Federal Reserve. And that’s quite a road trip for central bankers to attend a meeting…
Oh, who am I kidding? There will be plenty of private jets heading into Jackson.
Now, this isn’t just any event of global policymakers, central bankers, and economic leaders from around the globe. It’s also an opportunity for economists and policymakers to release research – usually around the primary subject of the event.
And this year’s theme… is RED HOT. It’s called: “Reassessing Constraints on the Economy and Policy.” Oh yeah. This should be a real scorcher…
Why This Jackson Hole Event Matters
The meeting will kick off in Jackson Hole this Friday with comments from Federal Reserve Chair Jerome Powell. And other policy leaders will speak. Unexpected remarks or warnings can fuel rather sharp market reactions. That’s why bond traders are so anxious about the event.
- What will be said about interest rates?
- What will people say about the central bank’s balance sheet?
- Will the Fed actually follow through and start cutting $95 billion from its balance sheet in September?
- How about the European Central Bank?
- What designer is Jerome Powell wearing?
Okay, maybe not the latter. But the first four are very important questions.
Sometimes, the event themes don’t match the drivers of the market. Historically – one of the most important stock market – “Oh No” – moments was in 2018 – when we saw the impact of the Fed’s balance sheet reduction. The Fed had long telegraphed the move around, cutting the balance sheet from a then-record $4.5 trillion… and hiking those cuts in the fall of 2018.
But before the Fed hammered the bond markets in November 2018 and the S&P 500 in December 2018, the subject of the Fed Symposium… was around Mega Cap technology companies.
The 2018 theme was “Changing Market Structures and Implications for Monetary Policy.” The chatter centered around the economic and market dominance of companies like Apple and Amazon and opened broad conversations on antitrust action. This meeting did little to forecast events in the markets two months later.
Why Should You Care
This event is where big, broad policies impacting global markets begin. The symposium with the most impact of the last decade was in 2014. That year, with Europe facing challenges, we had a speech from Mario Draghi, then president of the European Central Bank.
It mattered because Draghi rejected austerity measures that had impacted many nations across the European Union. You’ll recall economic problems in many different parts of the continent. The speech focused on monetary and fiscal policies to help spur demand across Europe.
As you can see, this paved the way for an incredible amount of debt expansion at the European Central Bank and sharp amounts of quantitative easing in 2015. Europe’s balance sheet exploded (more than doubling in three years)– and many other central banks followed suit.
This event can profoundly impact central banks’ approaches – even if the impact is longer-term. In addition… we find ourselves exposed to the policy changes as an unforeseen event in the future (COVID-19) fueled a greater expansion of these balance sheets and kicked easing into overdrive.
The consequences of the post-COVID monetary policies that emerge from this event and those that follow will be here for a long time.
What to Watch
In hindsight – long before I started focusing on these events and these trends – I’d say that 2007’s symposium remains foreign to our memory. That event had two extremely important papers that would offer clues into events happening during that dramatic economic decline into the back end of 2008. First was economist Robert Shiller’s “Understanding Recent Trends in House Prices and Home Ownership.”
The second was by economist Edward Leamer – “Housing IS the Business Cycle.” From Leamer’s paper, we can draw a straight line in understanding the importance of home investment as a sign of an upcoming recession and further understanding cyclical spending on the economy.
The chart below was shared by Eric Basamajian of EPB Research in July 2022. He writes: “Here’s the most important chart in macro. Explains the surge in growth, the overwhelming of supply chains, and the peak in the cycle. If the black line goes back towards the red line, the pain will be excruciating.”
The argument goes that housing, durable goods, and other spending in this vertical are core drivers of expansion and recession. If the cyclical spending as a percentage of GDP drops in the United States from current levels, we could be in for a very bumpy ride. If his thesis is correct… then we already have a problem in the housing market, and Leamer’s views from his 2007 paper prove their importance in understanding the state of our economy.
Today’s Housing Market
Today, we learned that July new home sales crashed to their lowest levels since 2016. And the number of new homes as part of inventory are at its highest since March 2009 – the height of the Great Financial Crisis. We continue to see enormous levels of existing home inventory hitting the markets, and a gigantic slowdown in housing sales.
In addition, the inability for Americans to buy new homes is pushing them into the rental market, fueling an increase in that vertical. This is important because rent is a very important component of the consumer price index (CPI). Tomorrow, we’ll look at the monthly durable goods numbers. We’ll also continue to look at manufacturing numbers, which suggest a nation that is barreling toward a recession.
Bond traders will be active ahead of Powell’s remarks at 10 am on Friday at the Jackson Hole Symposium. Overall – people expect a “hawkish” tone on interest rates, and traders started to cover bets on rate cuts in 2023 ahead of this week. It wouldn’t be the first time that Powell was “hawkish” about rate hikes and the balance sheet…
It’s just a question of whether people believe him – finally – this time…