Week Ahead: Jackson Hole, FOMC minutes & recession fear

Introduction

This is LCG’s look ahead to the week beginning August 19th. We discuss the upcoming Jackson Hole symposium, the release of the minutes from the latest FOMC meeting (the one in which the Fed cut rates for the first time since the financial crisis) – as well as the inverted yield curve and what it means for recession. We also run down the key economic data release for the week.
 

Markets backdrop

There is some Deja vu to this backdrop, its basically a continuation of last week but with some big new developments. This was the worst week of 2019 for equities, a fantastic week for bond markets where the US and UK yield curve inverted, US 30-year bonds hit a record low and all maturities of German government bonds had negative yields. Gold continues its advance while oil suffers from global demand fears and the dollar remains stubbornly strong, with only the yen doing better thanks to haven flows.

Events

EURUSD dropped back below 1.11 last week when the ECB member Olli Rehn said the ECB should come up with a “impactful and significant” stimulus package- that sounds like more money-printing (which devalues the euro) than the market was expecting. Eurozone CPI data will be a key one to watch to see whether the ECB has the low inflation figures to justify this kind of big dovish shift in policy. The next ECB meeting is September 12th- and it looks like the ECB could announce something big, suggesting more downside for the euro.

Fears of a US recession has sent The Dow Jones back below 26,000- having dropped 800 points in just one day last week. The FOMC minutes are now out-dated given the crashing bond yields that have happened in the two weeks since. Nonetheless, they cannot be ignored. Traders will be parsing through the minutes to test the vision of the rate cut in July as simply mid-cycle insurance. The minutes could hint at how close the Fed already was to switching from one or two insurance cuts to a new cycle of rate cuts – perhaps all the way back to zero. We think, given the schedule for next week – the minutes will be the clue and Jackson Hole will be the confirmation of whether Fed will expand plans for more rate cuts. With Jackson Hole happening, the market reaction to Fed minutes could be muted.

The belief that global central banks are turning the taps back on has been a big catalyst for Gold, an inflation hedge and haven when fiat currencies are being deliberately devalued. The precious metal touched $1535 per oz last week, which is a key level for traders. It was a price floor from late 2011 to early 2013 after the price reached a record high. Of course, the most important amongst the global central banks is the Federal Reserve.

Fed Chair Jay Powell’s speech at the Jackson Hole Symposium will be the key event of the week for markets. Oftentimes the “clues” about policy U-turns are first offered outside of the official central bank meetings. The inverted yield curve we saw last week is a message from markets to the Fed that short term rates are too high relative to long term inflation expectations. The big questions is “Hey Jerome, are you listening to bond markets?” We’re sure he is listening- but we don’t think Powell will want to be forced into promising stimulus when the US economy is doing well.

Central banks tend to act too late because they are watching lagging hard economic data like CPI, unemployment and GDP growth- rather than market signals like an inverted yield curve. This has been pointed out many times, but there has been an inverted yield curve before the last few US recessions – but not every yield curve inversion led to a recession. Given that the bond market is being unusually distorted by central action overseas- causing unusual phenomena like negative interest rates – it’s even more likely than normal that this yield curve inversion is a false signal. Of course a recession may be just around the corner, after all it has been over a decade since the last US recession. The point is that central bankers will be even less enthusiastic than normal about following a yield curve signal given the bond market distortions.

If Jay Powell doesn’t trust this “flashing light” from bond markets- he will stick his guns about mid-cycle insurance cuts. We think Powell could strongly hint at one more rate cut this year- which might cause an initial jump in risk appetite- but be quickly followed disappointment – causing a risk off move into gold, bonds, the US dollar and out of stocks and other currencies like the euro. Of course, if Powell does cave in to bond markets, gold would likely top out -and given the sharp sell-off in the last two weeks, a rip-roaring rally should ensue in stocks.