Breitbart Business Digest: Showdown at the Jackson Hole Corral

Next week Jerome Powell will find himself facing down financial markets at the feet of the Teton Mountains in Jackson Hole, Wyoming, each standing in the summer heat daring the other to blink first.

The market has been “fighting the Fed” for around two months. Stocks tumbled Friday to end what had been a four-week winning streak, but don’t let that fool you. The S&P 500 is up 15.3 percent since June 15.  Spreads between junk bonds and ultra safe U.S. Treasuries have narrowed dramatically. Mortgage rates have tumbled. The yield on the 10-year Treasury has fallen by 14.6 percent.

We expect that Federal Reserve Chairman Jerome Powell will come to Jackson Hole next week determined to show the market the error of its ways. First and foremost, this will mean correcting the way investors react to incoming data. From the Fed’s point of view, a barn-busting jobs number or a bigger than expected rise in retail sales is bad news not good news, for example. It signals the need for further tightening and indicates prior tightening has been less effective than expected. Powell will want to show the market that it needs to start interpreting signs of “resilience” in the economy as signs of persistent inflation that will be overcome with more tightening.

The delicate part here is that Powell and his fellow Fed officials are aware there is a risk of overshooting. They do not want to lock themselves into hiking three-quarters of percentage point at every meeting until inflation falls down to two percent because they believe monetary policy influences economic condition with long and variable lags. They would like to take their time with future hikes, which means smaller hikes and occasional pauses, to give the economy time to react.

To that end, Powell is likely to reiterate what we read in the minutes of the July meeting, Namely, that it is likely that the Fed will slow the pace of hikes at some point in the future and that the pace of hikes will depend on incoming data. What makes this tricky is that Powell must be careful not to sound too dovish here, leaving room for the market to interpret that the main risk to the base case of a “raise and hold” Fed strategy is a Fed cut. As we’ve seen in recent weeks, this dovish interpretation can quickly become the base case if the market does not receive a stern pushback from the central bank. Actually, in recent weeks the Fed’s “pivot” from hikes to cuts became the base case for many economists even in the face of stern pushback.

So Powell will likely need to explicitly reject the idea of a pivot. San Francisco Fed President Mary Daly previewed this in her remarks this week, saying the Fed was unlikely to quickly flip from raising rates to cutting rates. Powell will likely point out that the Fed’s projections released in June showed restrictive monetary policy extending into 2024. Where once the Fed’s mantra was “lower for longer,” now Powell will have to convince markets that its compass points to “higher for longer.”

One big question mark will be how openly Powell discusses raising into a recession or rising unemployment. Months ago, Powell seemed to indicate that he believed that much of the job of cooling the labor market could be done by cutting unfilled job openings rather than triggering layoffs. Does Powell still think this? If he says he does, the risk is the market will believe the Fed will flinch if it turns out monetary tightening is throwing Americans out of their jobs. By the estimates of some very well-known economists, unemployment may have to rise above five percent to bring inflation near the the Fed’s two percent target. Will Powell signal agreement with that?

It seems increasingly likely that the U.S. economy will fall into an indisputable recession in the near term. Powell’s speech will be the signal of how the Fed will react to that. Too much optimism about avoiding a recession will likely convince markets that the Fed will flinch if the downturn exceeds expectations. The market will believe that Powell will blink first.