Jackson Hole: What Has Been Said, Cannot Be Unsaid

All eyes are on the annual retreat of the central bankers at Jackson Hole, and all eyes were on the speeches of Janet Yellen and Mario Draghi (who showed up for the very first time since 2014). Whilst Yellen will very likely receive the usual comments and questions about the end of her official term as the chair of the Federal Reserve Bank, Mario Draghi could be the one who - in the end - claims most of the attention.

After not having attended the symposium in 2015 and 2016, it’s ‘interesting’ to see Draghi confirmed his attendance for this year’s conference and some are arguing this merely is a symbolic move. After all, back in 2014, Jackson Hole was when he announced the ECB’s Quantitative Easing program and it would be pretty symbolic for Draghi to announce the start of tapering at the very same conference, three years later.

Source: Danske Bank

Everything will depend on the ECB’s interpretation of economic growth in the Eurozone. It’s a fact the economy has now been growing for almost four years straight, but this doesn’t necessarily mean all issues have been solved as the recovery remains relatively weak and there’s a very clear ‘two speed’ difference between the countries inside the Eurozone as some members are obviously posting better growth numbers than others.

The ECB minutes in July showed the members of the European Central Bank were divided as to how to move away from the current extraordinary monetary policies. There really are just two possibilities on the table with one being the old school rate hike whilst the second one would be to throttle back the purchase rate of asset backed securities (the real quantitative easing program). You would think a central bank would first reduce the direct market intervention (the purchase of securities) before walking up the interest rates, but we have seen weirder things happen.

Source: Danske Bank

According to an interesting chart, provided by Danske Bank, it’s likely the ECB will reduce its QE purchases to zero by the second half of 2018, by gradually reducing the amount of money spent on those purchases.

This doesn’t mean the ECB will stop investing in asset backed securities. The 80B EUR of monthly purchases (which was subsequently reduced to 60B EUR) was the amount of ‘new’ money flowing into the securities. Just like the Federal Reserve is doing, the ECB will continue to reinvest the proceeds from maturing securities into new purchases.

But as we explained in a previous column, the recent strength of the Euro versus the US Dollar might derail the plans of the ECB. After all, a cheaper Dollar actually reduces the inflation expectations inside the Eurozone (as it becomes cheaper in Euro-terms to import goods sold in US Dollars). So will the ECB dare to make radical changes in its economic and monetary policy?

Whilst the Eurozone might have to wait to hike its interest rates, the exact opposite is happening in the United States where the economy seems to be accelerating again (obviously also helped by higher export numbers due to the weaker US Dollar), and whilst the market doesn’t seem to be expecting any substantial rate hikes, the futures tell us something different:

Source: CME Group

So either Mr. Market is right (and the interest rates won’t increase fast in the near and mid-term future), or the Fed will surprise the market by more and/or faster rate hikes than assumed. The market is pricing in a 47% possibility there will be no additional rate hikes by May 2018, and that’s quite a bold expectation.

Jackson Hole is where the masks fall off.

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