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Smart News - Jackson Hole, the Fed and inflation


Market Update

Jackson Hole, the Fed and inflation

It has been a relatively quiet week so far with little in the way of major economic news. But that’s not to say nothing is happening in the markets. Against the background of the coronavirus pandemic, both the S&P 500 and Nasdaq indices have hit fresh record highs. They have also been helped along by a raft of better-than-expected economic data and second-quarter corporate earnings.

Yesterday's US Durable Goods comfortably beat analysts’ forecasts. Meanwhile, the earnings season winds down and as we wave goodbye to the summer, we get deeper into the third quarter. Now all eyes turn to the annual economic symposium hosted by the US Federal Reserve at Jackson Hole, Wyoming. For the first time, this meeting of central bankers, finance ministers, academics and other notable financial market participants will be held remotely due to coronavirus travel restrictions. The highlight will undoubtedly be the opening speech today from Federal Reserve Chairman Jerome Powell.

Ahead of the speech, there has been considerable excitement amongst market analysts and lots of speculation about its contents. The prevailing view is that the Federal Reserve Chairman will have plenty to say about inflation, one of the two pillars of the central bank’s dual mandate, the other being to ensure maximum employment. The feeling is that Mr Powell will address one of the biggest concerns around the issue. That is, the Fed’s inability to drive inflation, as measured by the headline inflation indices, up to its target rate of 2%. This is of great importance to central bankers, as they believe that if inflation is persistently low it reflects a slow-moving economy with low standards of living. Bear in mind that despite all the monetary stimulus that the Fed has provided since the financial crisis of 2008, inflation has stayed below that target level for all but two years. Yet while traditional measures have failed to register much inflation, there’s little doubt that it is showing up in asset prices, such as equities, bonds and property. This is great for holders of such assets, but not much good for the vast majority of individuals who can’t even dream of buying them.

Mr Powell’s speech is expected to address the divergence between runaway inflation in asset prices (bad inflation) and modest wage pressures and real economy prices (good inflation). He is expected to talk about how the Fed plans to get inflation back up to, and even above, the 2% target. Members of the central bank have been saying for a long time that they would be happy to see headline inflation run above their target rate. This would help to even out the fact that it’s been below target for so long. The expectation is that we will now hear plenty of talk around “average Inflation” targeting, rather than looking at a specific target number.

A finger turns two dice and changes the word spelled out from 'inflation' to 'deflation' and vice versa

As far as investors are concerned, this suggests that the US central bank is effectively saying that it won’t even think of raising interest rates until inflation gets up to 3 or even 4%. On one hand, this should be quite reassuring for investors. It means they can stop worrying about the Federal Reserve tightening monetary policy thereby risking another ‘taper tantrum’ which led to a 20% sell-off across global equities in the last three months of 2018. On the other hand, once it gets going, inflation is notoriously difficult to control. If an economy becomes overheated, central banks have to take drastic measures to prevent spiraling prices. The other issue is just how effective are low borrowing rates when lenders are reluctant to lend? But that is a problem for another day as far as most investors are concerned. Most expect Mr Powell to suggest that interest rates will remain low for a considerable time to come. The trouble is when expectations are high and all in one direction, there’s plenty of scope for disappointment.

So, it’s shaping up to be an interesting end to the week. It’s also going to be important to stay on top of events as they happen. To follow Mr Powell’s speech and to get instant analysis from the big thinkers and influencers on social media, click on our Smart News widget in the bottom right corner of the trading platform. If you’re not sure where it is, have a look at the vlog which accompanies this article. This will help you keep a step ahead of the mainstream media.

 


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