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Inside the Broker - Investors cautious ahead of Jackson Hole

Inside the Broker

Investors cautious ahead of Jackson Hole

At the beginning of last week both the Dow Jones Industrial Average and the S&P 500 hit fresh record highs. Both indices had been rangebound for the latter half of July and early August. But they managed to break above resistance in a move which saw the S&P push above 4,480 while the Dow topped 35,600. Then the bullish run suddenly ran out of tarmac as both indices fell around 3% between the market close on Monday and Thursday morning. Most of the blame for the losses was put on the release of minutes from July’s US Federal Reserve monetary policy meeting. The minutes indicated that most members of the Federal Open Market Committee (FOMC) wanted to start winding down the $120 billion bond purchase programme before the end of this year. But the sell-off in global equities began well before the release of the Fed minutes. Last Monday China released weaker-than-expected numbers on Retail Sales, Fixed Asset Investment, and Industrial Production. This helped to undermine positive sentiment as investors worried that an earlier rise in Chinese coronavirus cases were showing up in the data and slowing the pace of economic recovery.

Improving US payrolls

As for US, the latest Non-Farm Payroll (NFP) update at the beginning of this month had already raised expectations that the Federal Reserve may soon want to taper its bond purchase programme. July’s NFP report showed an increase of 943,000 jobs which was well above the consensus estimate of 870,000. Additionally, the prior reading was revised up to 938,000 from 850,000. Overall, this was a big step toward the Federal Reserve’s goal of “substantial” economic progress. But there’s still a shortage of around 5.5 million jobs from the pre-pandemic days. So, while the payroll numbers are going in the right direction, the Federal Reserve can still point to this shortfall as an excuse for taking things slowly when it comes to winding down its stimulus package.

No surprise

All in all, the FOMC’s comments on tapering this year shouldn’t have been a surprise to anyone. Plenty of Federal Reserve members have recently expressed the opinion that tapering should soon get underway. It’s also worth pointing out that tapering would not necessarily mean an imminent increase in interest rates. Bear in mind, the last time the Federal Reserve reduced its balance sheet, US stock indices rose steadily. It was only when the Fed concurrently, and aggressively, raised rates did investors respond by dumping stocks. The S&P fell 20% in the last quarter of 2018, in a move which effectively forced Fed Chair Jerome Powell to halt further stimulus reductions. It would be something of a surprise for the US central bank to make the same mistake this time round.

Timing the taper

The big question now is when the Federal Reserve will announce its timetable for winding down its bond purchases. The next FOMC monetary policy meeting takes place on 21st – 22nd September, and this would appear to be the best opportunity. But this week we have the Jackson Hole Economic Symposium where Mr Powell will deliver the keynote speech on Friday. While it’s unlikely that he will be explicit in explaining what the Federal Reserve is planning, it’s quite likely that he will prepare investors by confirming that tapering is imminent. Before then, the US Durable Goods report comes out on Wednesday while we get an update on second quarter US GDP on Thursday. On Friday, not only will we hear from Jerome Powell, but we’ll also get the latest update on the Federal Reserve’s preferred in inflation measure, Core PCE. Hopefully this may help to clarify the contradictory messages from the recently released CPI and PPI data.

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