Awaiting Jackson Hole

In the midst of COVID-19 crisis, the big picture is rates are going nowhere fast, secular stagnation fuels the proliferation of zombie companies and financial repression looms large fuelling mounting inequalities and wealth disparities throughout broader society. “We’re not even thinking about thinking about raising rates,” Powell told reporters post the June FOMC meeting.

Despite this, the Jackson Hole speech delivered by Chairman Powell tonight will still be consequential for traders and risk assets alike. With central bank watchers poring over Powell’s every word for confirmation of dovish ramifications and clues on the outcome of the year-plus monetary policy framework review. This year’s Jackson Hole theme is “Navigating the Decade Ahead: Implications for Monetary Policy.” Although a formal announcement is not expected, Powell may signal where the Committee are placed in terms of changes to monetary policy and their new inflation commitments. Commentary which will be key for the continuation of the speculative met up in risky assets aggressively recouping their COVID induced losses. And the plunge in real yields supporting precious metals.

The July FOMC minutes pushing back on the prospects of YCC, which is likely off the table for now, raising the likelihood of outright forward guidance and average inflation targeting (AIT) becoming a key piece of the Fed’s fresh commitment to achieving their inflation target.

This could include a commitment to keeping the fed funds rate close to zero until actual inflation reaches and preferably exceeds 2% target. Then add in a dash of average targeting, which could see a range of 2%-4% inflation tolerated, as an offset to inflation running below 2% for so long prior. Making a clear signal that the Fed are determined to see inflation above 2% in tolerating a temporary overreach. These accommodative policy changes will be pivotal for real yields if the Fed commit to anchoring nominal yields, music to the ears of growth stocks, and precious metals that thrive off the persistent collapse in real yields. But also the commitment to inflation driving demand for alternative assets, hard commodities and inflation hedging. And without anchoring nominal yields, the commitment to inflation, if yields pick up will be detrimental to the performance of growth stocks - primarily the long duration mega caps whose relative attractiveness has been boosted by low rates. 

With the very notion of continued central bank intervention, zero rates for years to come and AIT in mind, gold and silver futures have notched up their highest finish in a week, as expectations run high for Powell’s speech.

Although Powell will be wary of disappointing asset markets whilst the real economy flounders in the wake of the global pandemic, it seems the bar to disappoint could be relatively low given the expectations surrounding AIT already embedded. Last week’s disappointment to the July FOMC simply being “not dovish enough” stoked sharp reversals across the risk asset and precious metals complex. The feverish buying in the Nasdaq, and almost parabolic trend, this week makes us wary into tonight’s speech of a corresponding sharp reversal should disappointment ensue.

Rising Nasdaq volatility (VXN), alongside a surging index itself also flashes warning signals that all may not be rosy beneath the surface. Particularly as the spread between the VIX (S&P 500 volatility) and VXN sits at a historic extreme, last witnessed prior to the Volmageddon meltdown in February 2018. This corrects one of two ways, VIX rises or VXN falls. However, rising volatility in conjunction with fresh highs for the Nasdaq signal mounting fragilities and renders the feverish upwards trend, accompanied with FOMO buying, prone to sharp reversal, regardless of the content of Powell's speech.

As we have said before, although we believe technology companies leveraged toward the secular growth thematics accelerated by COVID-19 will outperform in the medium/long run, valuations and excessively one sided crowded positioning make us tactically cautious with respect to entry to this trend at present. In other words don’t buy growth at any price! Opportunity can be found elsewhere as market leadership broadens within more cyclically oriented sectors, where the risks of overly crowded positioning and excess speculation are not prevalent. Clearly these allocations require the participation of the real economy for true outperformance. However, with the Fed set to make a serious commitment to inflation, commodity, metal and mining stocks represent not only a hedge against rising inflation expectations, but also the bubblicious environment in crowded growth and tech names. A key diversification benefit for portfolios. 

Complacency and manic speculation are the name of the game for now, but risks are accruing, and when sentiment shifts, liquidity quickly disappears. Then, the previous stability in the seemingly never-ending melt up is destabilizing in itself, as every rushes for the same exit. Particularly with the increased retail and hot money participation chasing momentum in high-flying stocks. These dynamics increase the risk of compulsive selling when sentiment shifts. Long growth/short value positioning remains at a historical extreme and any reversal in this positioning will be painful.