Investors see no pivot from the Fed, prepare for Powell’s hawkish message in Jackson Hole

Chairman of the Federal Reserve Board Jerome Powell speaks during a news conference following a two-day meeting of the Federal Open Market Committee (FOMC) in Washington, United States, July 27 2022. REUTERS/Elizabeth Frantz/File Photo/File Photo

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NEW YORK, Aug 24 (Reuters) – Investors are bracing for the Federal Reserve to step up its efforts to crush inflation and expect its chairman, Jerome Powell, at the central bank’s annual meeting in Wyoming this week, delivers an aggressive tightening message and is rushing to hope for a rate cut next year.

Jackson Hole, Wyoming’s pullback comes after investors last week viewed transcripts from the Fed’s July meeting as a dovish slant and a green light to put some risk back on the table. The stock market initially resisted and bond yields remained stable, before the markets reconsidered this interpretation.

Since the release of the Fed minutes on August 17, the S&P 500 (.SPX) has fallen around 3.8%, the benchmark 10-year Treasury yield has risen around 10 basis points (bps) and climbed back above 3%, and the dollar appreciated about 1.7% against the yen, the currency pair most sensitive to rate expectations.

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Powell’s speech Friday morning could cement the market’s tone until the next Federal Open Market Committee meeting next month.

“Caution and fear are the theme of the markets,” said Steven Englander, head of G10 global currency research and North American macro strategy at Standard Chartered in New York.

“If Powell says something hawkish and you buy emerging market stocks or currencies, you’ll lose 3% before you can blink. So no one is buying risk right now as Jackson Hole approaches. .”

The Fed, in July meeting minutes, said it saw “little evidence” that inflationary pressures had eased, but acknowledged the risk that it would tighten too much and dampen economic activity. . Read more

Fed funds futures have priced in a 51% chance of a 50 basis point (bp) rate hike next month, with the fed funds rate hitting 3.6% by the end of the month. ‘year . A week before Wednesday’s minutes were released, the rate futures market had priced in a 75 basis point rate hike.

Eurodollar futures have forecast at least one rate cut between March and December 2023, with the spread between the two contracts at around -44 basis points on Monday. The peak federal funds rate is estimated at 3.9% in March, according to Eurodollar futures.

Harley Bassman, managing partner at Simplify Asset Management in Laguna Beach, Calif., thinks the pricing of rate futures is a long way off.

“I think the Fed is going further than the market thinks in terms of rate hikes. I don’t think inflation will hit 2%-3% next year. It’s baked in the cake,” Bassman said.

A drop in fuel costs left US consumer prices unchanged in July, reinforcing a scenario of moderating inflation, although underlying price pressures remained elevated. Producer prices also fell last month due to cheaper energy.

Annual percentage changes

“Basically, we’ve seen house prices go up 10-20%,” Bassman said. “And you’re going to see the OER (equivalent owners’ rent) continue to rise for the next six to nine months. So the actual CPI printout going to the newspapers is going to continue to rise over the next 12 months. “

Perhaps to complicate Powell’s message, second-quarter U.S. core personal consumption expenditure price data, an important inflation indicator for the Fed, is due out an hour and a half before the speech. from the Fed chief from 10:00 a.m. EDT / 2:00 p.m. GMT.

However, the bond market is pricing in less disastrous inflation. One indicator, break-even inflation, which measures the difference between the yield on US Treasury inflation-protected securities (TIPS) and nominal Treasuries, has declined since mid-June from maturities to one year to 30 years, according to Refinitiv data.

LESS FRONT LOADING OF RATE HIKES?

The Standard Chartered Englishman thinks the Fed will do whatever it takes to bring inflation back to its 2% target, but it won’t make all the hikes in future meetings.

“They might say something like, we’ll walk as long as we have to, as high as we have to, but we don’t have to in the next two or three games,” Englander said.

Ahead of Jackson Hole, speculators’ net long position in the safe-haven dollar rose for the first time in four weeks, according to Reuters calculations and US Commodity Futures Trading Commission data released last Friday.

Specifications increase net dollar purchases

“The market is panicking as Jackson Hole approaches,” Englander said.

Certainly, some market participants believe that the Fed has an opportunity to reduce its pace of tightening due to the slowing US economy.

The Fed might not tell Jackson Hole, though.

Jeffrey Roach, chief economist at LPL Financial in Charlotte, North Carolina, cited a tightening cycle in the mid-1990s, during which the US labor market weakened. The Fed responded by keeping rates unchanged while monitoring the economy.

“There’s still a chance for the Fed to make a soft landing here,” Roach said.

A soft landing for the US economy is not the baseline scenario for Simplify’s Bassman, however, and a recession is certainly on the horizon.

“So you want to buy fire insurance. I’m crazy bearish on rates. I see reasonable rate scenarios — whether it’s the 10-year note or the fed funds rate — going up to 4% or more. “

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Reporting by Gertrude Chavez-Dreyfuss; Editing by Alden Bentley and Chizu Nomiyama

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