ECONOMIC UPDATE

  • Fixed income markets remain highly sensitive to expected monetary policy shifts given the heavy presence of the Fed and other major central banks
  • Fed Chair Powell did not mimic the more hawkish rhetoric of his regional Fed bank colleagues in his Jackson Hole address; market pricing for Fed liftoff has remained largely unchanged since the first quarter
  • The July jobs report was much better than expected, boosting optimism in the ongoing labor market recovery

Fixed income markets, in general, remain fixated on monetary policy in the current environment. The Fed’s balance sheet has doubled since early 2020 to more than $8.3 trillion in total assets, which has impacted market supply and demand technicals across all sectors in a considerable fashion. Asset spreads have grinded to historically tight levels, and utilization of the Fed’s overnight repo facility has spiked to record high levels amid the flood of liquidity in the money market space. In this context, the hyper-focus on comments by Fed leadership for any hint of policy shifts becomes more understandable, and as such, Fed Chair Jerome Powell’s annual speech from the Jackson Hole Economic Symposium on August 27 was highly anticipated. The speech has become a much watched, if not over-hyped, event each year since former Fed Chair Ben Bernanke effectively announced the third round of quantitative easing (QE3) by the central bank in 2012. There have not been any major revelations in recent years, although last year’s unveiling of a policy framework shift to average inflation targeting was perhaps the most impactful announcement of all from a long-term perspective. That said, with the economy rebounding swiftly with inflation readings not seen in decades, investors are more sensitive to any hints regarding the timing and pace of the ultimate (and potentially great) unwind.

Leading up to the Jackson Hole speech, several regional Fed bank presidents made hawkish comments related to asset purchase tapering, with James Bullard (St. Louis Fed) going so far as to suggest on August 26 (the day before Powell’s speech) that the central bank should “get the taper finished by the first quarter next year.” However, Powell didn’t appear especially persuaded by his regional bank colleagues at the FOMC during his August 27 address. As he usually does, Powell resisted pressures to make a bold statement and instead effectively repeated the company line from recent communiqué. As the July FOMC meeting suggested, he confirmed that “it could be appropriate to start reducing the pace of asset purchases this year.” In other words, all future meetings are “live” for a taper announcement, but Powell was more neutral in his tone, unwilling to convey the urgency expressed by some of his non-Washington based colleagues. Powell also made sure to remind everyone that tapering is not the same as tightening, rather just the opposite. Tapering slows the pace of monetary accommodation, but the Fed’s balance sheet is still expanding. He took it a step further by emphasizing that whatever the committee decides regarding the timing and pace of tapering, it “will not be intended to carry a direct signal regarding the timing of interest rate liftoff.” This is an important distinction that wasn’t well understood back in 2013 when Fed leaders first suggested tapering the prior QE program.

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