Australian markets strategist, Saxo Bank
Summary: Ahead of the annual Jackson Hole Economic Symposium chairman Powell is once again juggling with market expectations whilst facing an ever-oppositional barrage of insults from an irate US President Donald Trump. Asian indexes nervously climbed today on low volumes ahead of tonight’s speech and yields rose along with the USD as Fed officials reigned in the dovish cooing. Markets are nervy as they attempt to navigate ongoing trade tensions, geopolitical fractures and a synchronised slowdown in global growth. Pervasive uncertainty remains and as such traders are anxiously looking to the Fed for direction as chairman Powell delivers his opening speech at the symposium tonight in Wyoming.
Throughout his tenure as chairman Powell has not proven himself to be particularly adept in navigating Fed communications, with many a blunder under his belt. Unlike one of his predecessors, Alan Greenspan, Powell has attempted to deliver a straightforward narrative but to date his conversational tone has led to many a misunderstanding in financial markets. One hopes tonight will be different but against a tightrope of market expectations Powell faces an immense challenge if he is to try and reposition the Fed ahead of the curve, unless he leans well against the more hawkish commentary that has emerged so far this week. There are now three members of the committee who have publicly opposed further easing with Esther George from the Kansas City Fed following Harker and Rosengren, saying “it’s not time yet’ for further easing measures.”. These comments saw the yield curve invert for the third time this year. The speech tonight will be closely watched ahead of September’s Monetary Policy Committee meeting where the market is betting against Powell’s prior “mid-cycle adjustment” narrative and pricing in a prolonged spate of easing beginning with 25bps in September and another 75bps of cuts over the next year, so is desperate to hear that rates are going one way only (DOWN!).
Will Powell deliver on a communique that is dovish enough to position the Fed ahead of the curve and ease investors nerves with a delicate balancing act of market pricing across multiple asset classes. Equities, faced with a deteriorating outlook for corporate earnings need continued valuation support from a prolonged easing cycle and a lower discount rate increasing the present value of expected future cash flows, justifying higher valuations as interest rates fall in order to cling to their complacent climb. US growth has peaked, the dollar remains strong (40% of SP500 companies generate a significant proportion of their earnings overseas) and the corresponding period last year represents a peak in earnings growth for SP500 companies that will make for some formidable base effects. On that basis consensus estimates remain too high on the outlook for earnings over the coming quarters, in fact we see risk of an earnings recession in the period ahead. Against the current economic backdrop with a myriad of factors weighing on revenue growth, the forecast v-shaped recovery in earnings growth through to FY2020 looks far too optimistic. In the near term, for equities to regain their highs the dovish rhetoric needs to be ramped up in order to fuel a continued complacent dash, otherwise a retest of June lows looks like the next move. To be clear, over the medium term as outlined above risks to the bullish move we have seen off December 2018 lows are rising, and current valuations are inconsistent with exhausted growth outlooks.
At present the manufacturing and industrial sector are already in recession, not a single G7 economy has a Markit PMI above 51 and firms across the US, Europe and Asia Pacific have slowed business investment. Both as a cyclical downturn weighs and the uncertainty surrounding the trade war paralyses corporate investment and capex decisions. To date this slump has not yet fully permeated the services sector and private consumption which has been propping up the global expansion. Overnight, the Markit US Services and Composite readings fell to a new low of 50.9, highlighting that the potential for recessionary dynamics in the manufacturing and industrial sector to permeate the services sector and knock on to the labour market and consumption is a very real risk. And one that policy makers must move to avoid as a hit to the labour market, private consumption and consequently consumer confidence would accelerate the end of the cycle and raise recession risk.
Bond markets need to hear Powell regain understanding of the dynamics in play and drop the mid-cycle adjustment” theory to avoid repricing and curve flattening. To date the bond market has had little faith in Powell's “mid-cycle adjustment” theory (rightly so). If forward guidance continues to be less dovish, cementing the view that the Fed are already well behind the curve this is likely to be interpreted as a policy error, with short end rates too high, therefore raising the risk of recession and pressuring inflation expectations. The yield curve has been telling us for some time that monetary policy is too restrictive indicating monetary stimulus to date will fail to engender a re-acceleration in growth or inflation.
A less dovish Powell would also be supportive of the USD but would be counterproductive in confirming Powell’s narrative as a stronger USD is only going to mean more aggressive easing from the Fed is coming at a later date.