Has "For Now" Changed? The One Question Powell Must Answer At Jackson Hole

The Jackson Hole Economic Policy Symposium - traditionally the end of US central bankers' summer vacation - will be held between the 23rd and 25th August 2018.

While the host Kansas City Fed will release the full schedule of speakers and participants at this year's conference - whose official theme is the economic impact of superstar firms like Amazon - on Thursday at 8 p.m. EDT, investors will be closely watching the keynote speech from Fed chair Jerome Powell in which he is expected to provide clarity on a variety of issues, ranging from the future path of interest rates and balance sheet policy, to the Fed's latest take on emerging-market turmoil.

While the Fed is expected to hike rates again next month, and perhaps once more in December as the US decoupling from the rest of the world accelerates, markets are curious if the recent shake up in emerging markets has led to a change in policy, and if the Fed will slow down its gradual tightening path, according to Bloomberg. When speaking to Congress in his semi-annual testimony, Powell said that gradual rate hikes were appropriate "for now."

No surprise then that the market's core focus will be on whether Powell's assessment of what "for now" means has changed.

In his preview of the main event at Jackson Hole, Jefferies' chief financial economist Ward McCarthy said that "this whole issue of how they’re going to change the language of their guidance on the path of rates, and what ‘for now’ means is really what they need to get on to."

There's more.

In his testimony to Congress, Powell also noted that the Fed would take up the question about the size of its balance sheet "fairly soon." The ongoing runoff is reducing the level of reserves in the banking system, resulting in a drain of dollar liquidity which to many has been the key catalyst behind much of the recent emerging market turmoil, as well as stress in front-end rates - most notably the IOER - thus affecting the Fed’s ability to manage the federal funds rate.

Mark Cabana, head of U.S. short-term interest rates at Bank of America, said more direction from the central bank "needs to be forthcoming" especially with increasingly more banks speculating that the Fed's balance sheet shrinkage will come to an end far earlier than expected: as we discussed last week, Morgan Stanley and RBC analysts said last month the balance-sheet runoff could end as early as 2019, while Goldman Sachs strategists in May said they’re assuming an end around April 2020. BMO's Ian Lyngen went so far as to suggest that shortly after the Fed announced an end to its balance sheet shrinkage, it would then launch a fresh round of debt monetization.

While it remains to be seen if the recent stress in emerging markets, particularly Turkey, will be an official topic it is likely to generate significant sideline discussion at this year's gathering. Economists predict, however, that unless global financial conditions worsened considerably, the Fed wouldn’t delay hiking in September.

The reason: the US economy has continued to surprise to the upside, with strong GDP, unemployment and core inflation of 2.4% well above the Fed's 2.0% target, and suggesting the Fed may be falling further behind the curve even as the threat of even higher prices due to import tariffs lurks just around the corner. And while in recent years, international uncertainty has been more than enough to prompt officials to tap the brakes on tightening this time may be different due to America's accelerating decoupling from the global downtrend.

"Until [Emerging Markets] represent a proximate threat to the U.S. economic outlook, the Fed will probably not be deterred from doing the appropriate thing on the basis of domestic fundamentals,” said Carl Tannenbaum, chief economist at Northern Trust Corp. in Chicago.

The market seems to agree, and short-term rates in the US remain stubbornly close to their post-crisis highs, while the yield curve has also flattened to post-2007 lows, even as Treasury net speculators are holding record short positions.

There is a third key question that will need addressing: what happens when the US inevitably recouples with the rest of the world. While the US economy continues to fire on all fours - mostly as a result of Trump's stimulative fiscal policy - the global economic picture isn’t quite as rosy. In addition to emerging-market worries, trade disputes and hints of cooling growth in China pose risks to global expansion.

For the answer, markets will look to foreign central banks present at Jackson Hole, although here there will be fewer surprises.

The ECB in June brought back "forward guidance" from the dead when it laid out a clear policy path over the next year: it plans to end QE by the end of 2018, and keep interest rates at record lows "at least through the summer of 2019" putting it at risk of losing credibility should inflation spike in Europe in the interim. Then again, a greater risk is the return of deflation and Mario Draghi has repeatedly warned that "prominent" global uncertainties are the main downside risk to the otherwise robust expansion. It's not immediately clear who from the ECB will speak: the latest weekly schedule of public speaking engagements and other activities published by the ECB for August 17-26 does not list any ECB Governing Council Member’s speech at the Jackson Hole conference, though some officials are likely to attend.

The BOJ also made sure to reveal its biggest surprise last month, when it made the most significant adjustments to policy in two years in July, when Governor Kuroda said that the bank will re-calibrate its bond market operations over the coming months to allow for higher 10-year yields. There are expectations that the BOJ will accelerate its stealth tapering in its exchange-traded funds purchases after it said the volume of buying would depend on market conditions.

Meanwhile, the Bank of England which recently prompted speculation of policy failure when it hiked rates recently only to see the Pound tumble, is wrestling with the implications of the country’s imminent Brexit - whether hard or soft - from the European Union; the bank hasn’t announced whether Governor Mark Carney will make it to Jackson Hole.

Finally, there is the official theme of the Jackson Hole symposium: this year's proceedings will pertain to the theme of "Changing Market Structure and Implications for Monetary Policy." According to Bloomberg, research papers being presented and most of the formal conference discussions, will focus on increasing market concentration across developed economies and "superstar firms." Related to this, just this morning we showed that a handful of superstar companies, i.e. tech names such as Google, Microsoft and Apple, have accounted for 60% of the gross profit margin growth in the past 20 years, while the bulk of the market has seen little to no improvement in its profit margin.

And with fewer firms controlling larger market shares in many industries, economists have been studying whether this creeping monopolization of the market reduces competition, with negative consequences for consumers, workers and the economy, and the deflationary impact from tech innovation. As a reminder, it was roughly this time last year that the Fed was engaged in a scapegoating campaign blaming the likes of Amazon for being unable to hit its inflation target.