Ear to the Ground

September 2 2022

The US Federal Reserve Chair Jerome Powell took markets by surprise at the Jackson Hole Symposium last week.  Many market commentators had been expecting him to deliver something of a pivotal moment.  A softer stance on monetary policy tightening, in particular interest rate hikes, was envisaged given the softer economic data coming through and fears of a recession.  Instead, he came across as very resolute in that they need to remain focused on tackling inflation and bringing it back in line with target very early into his speech.  Key statements from it included;

“The Federal Open Market Committee’s (FOMC) overarching focus right now is to bring inflation back down to our 2 per cent goal.  Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy.”

“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance.  Reducing inflation is likely to require a sustained period of below-trend growth.  Moreover, there will very likely be some softening of labour market conditions.  While higher interest rates, slower growth, and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses.  These are the unfortunate costs of reducing inflation.  But a failure to restore price stability would mean far greater pain.”

“Restoring price stability will likely require maintaining a restrictive policy stance for some time.  The historical record cautions strongly against prematurely loosening policy.”

This left the market very clear that tackling high inflation remains the number one concern of the Federal Reserve right now.  They acknowledge the shorter-term negative impact that this will have on economic growth, but that action now will benefit the economy over the longer term.  They most certainly appear nervous about making a policy mistake by easing up on the current policy too soon.

Markets reacted to the statement made, with the US 10-year Treasury yield being at 3.26% at the time of writing, up from 3.03% on the 26th.  Equities reacted to the statement also.  Since its 25th August close the S&P 500 is down 5.53% at the close on the 1st of September.  Losses were felt harder within more growth-orientated stocks, with the Nasdaq Composite for example down 6.76%.

The continued upward pressure is also causing some concern for the US housing market.  House prices themselves have posted gains since 2020 which are now way above their long-term trend by reference to the median sales price of houses sold.  Any reversion to the trend could therefore be painful.  Housing affordability is proving very difficult, compounded by sharp increases in US mortgage rates.  The 30-year fixed rate mortgage average stood at 6.23% on the 1st of September according to data from Mortgage Daily News.

Could there possibly be a glimmer of light ahead, however?  Data from ISM and BLS shows that historically there is a long-term relationship between the US manufacturing prices paid index and US CPI inflation.  This relationship appears to have broken down recently, with the former having turned lower whilst CPI remains stubbornly high.  Is there a delayed response in CPI in the offing?

One of the main causes for concern for both the public and businesses remains the high cost of energy.  Here in the UK, we are to see the next adjustment to the price cap in October, increasing yet more financial pain on the end user.  We will need to wait until the appointment of the new Prime Minister to see what intervention or support if any, comes from the government.

In Europe meanwhile, the threat of intervention by the EU has had a marked effect on the forward pricing of natural gas and electricity.  This has been seen across key countries such as Germany, France and Netherlands.  That still leaves prices at elevated levels but like we said earlier, just a glimmer?

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