On the Main Menu:
The annual Jackson Hole Symposium kicked off yesterday under the theme, “Navigating the Decade Ahead: Implications for Monetary Policy”. The opening remarks were made by US Fed Chair Jerome Powell, in which he unveiled the outcomes of Fed’s review of its monetary policy framework, which happens every five years. Like the announcement of QE during the financial crisis was a significant change for monetary policy for the next decade, this change in the Fed’s monetary policy framework has significant implications for global monetary policy. I have the next decade, perhaps my whole lifetime to understand the implications, given that even the implications of QE are still not well understood globally.
So, let’s begin. As in most cases in economics, initial conditions matters. The review took place in an environment where changes in output or unemployment rate resulted in little change in inflation, the so-called flat Phillips curve. In addition, economic growth has been structurally low and inflation expectation has been stuck below the Fed’s target of 2% for all of the last decade. To complicate matters, the covid-19 pandemic is restructuring the underlying economy in ways no one currently understands. Here are key aspects of the new framework.
· The new framework, which could be called average inflation targeting, seeks to achieve an average inflation rate of 2.0% over time. This means that following periods where inflation undershoot the 2% target, inflation will be allowed to overshoot this target for a while before the Fed response.
· The Fed has also tweaked its employment mandate to achieving maximum employment from its focus on deviations from the natural rate on unemployment.
My initial thoughts on what this mean for the current policy setting are as follows. Given an economy in deep recession, inflation risking deflation and the high unemployment rate, the Fed will keep policy rates low for a very long time, and until inflation averages 2.0%, which will require inflation expectations to be above 2.0% for as long as inflation has been below 2% and by as high as inflation has been below 2%. Okay, let me clarify that. The length over which inflation expectations will have to average above 2% will depend on how high above 2% in the inflation is, the higher the inflation expectations above the 2% target the shorter the time period the Fed will have to respond. The opposite is also true.
Essentially, the Fed has bought itself flexibility in that it will allow the economy to overheat before it respond, relative to its past reaction function. It will be still data dependent but less reactive to the data.
So what for SA and other emerging markets. This is good news. Less concerns about rising global cost of capital for some time mean there is more time to do the structural reform without having to overly worry about the potential for rising global risk free rates. Events like the taper tantrum are a long distant away and thus likely less volatility and swings in asset prices.
Who are we reading:
It’s all about the Fed’s Review of Monetary Policy Strategy, Tools, and communications, which admittedly came early. I had expected it to be released at the September FOMC meeting. Several papers are housed on the Federal Reserve Bank of Kansas City. There are six key themes.
· Why Has the Trend Rate of Growth Declined?
· Why Are Interest Rates So Low?
· Crisis Management in the COVID-19 Economic Shutdown
· Micro Uncertainty and Policy Uncertainty
· Expectations and Monetary Policy
· Post-Pandemic Monetary Policy and the Effective Lower Bound (ELB)
While you were sleeping:
· Following US Fed Chair Powell’s dovish speech, US and UK bond yields are up: US 2Y (+4.4bp), 10Y (+6.4bp); UK 2Y (+0.1bp), 10Y (+3.4bp). Eurozone bond yields are down on the short end and up on the long end: German 2Y (-1.4bp), 10Y (+0.8bp); Italy 2Y(-1.8bp), 10Y (+0.3bp);
· Global equities were mostly down: MSCI ACWI (-0.1%), MSCI World (-0.1%)
· US markets were mixed: S&P 500 (+0.2%), NASDAQ (-0.4%)
· European markets were down: MSCI Europe (-0.7%), Euro stoxx (-0.8%), UK FTSE 100 (-0.8%), France CAC 40 (-0.7%), German DAX (-0.6%)
· Asian markets were mixed: MSCI Asia Pacific (-0.4%), China Shanghai composite (+0.6%), India Nifty (+0.1%), Japan topix (-0.5%) and Hong Kong Hang Seng (-0.8%).
· Latin America markets were down: Brazil, Mexico and Chile were all down -0.7%, -0.8% and -0.1% respectively.
· JSE was up +0.5%: Top40 (+0.6%), Large cap (+0.7%), mid cap (-0.4%), small cap (-0.9%), basic materials (-0.3%), mining (-0.3%), gold mining (-2.0%), platinum and precious metals (+0.7%), industrials (+1.3%), general industrials (-0.2%)
· Commodities were mostly down: Brent crude oil (-1.2%), gold (-0.1%), copper (+0.3%)
· Sovereign risk as measured by credit default swaps spreads (CDS) was mostly flat in emerging markets.
· In currency markets, the US dollar index (DXY) was flat along with a number of emerging markets barring the Brazilian real (+0.8%), Russian rubble (+0.6%), Indian rupee (+0.7%).
Data out today:
· South Africa’s monthly budget balance, expected to print a deficit of R116.8bn in July from a deficit of R22.3bn in June.
· US personal income and expenditure expected to print -0.3% and 1.6% in July from -1.1% and 5.6%, respectively.
· US Core PCE deflator, the Fed’s preferred measure of inflation, which is expected to have printed 1.0% in July – way below 2% target – from 0.8% in June.
· Germany consumer confidence and France inflation and GDP figures. France’s inflation expected to moderate to 0.1% y/y in August from 0.8% previously, GDP expected to print -13.8% q/q.