Digging yourself a (Jackson) hole!! - Global market update

I have never been to Jackson Hole, Wyoming, and while the thought of seeing the great outdoors in the Pacific Midwest of the US is very appealing, the idea of spending even an hour at one of the world's most influential annual gatherings of central bankers, economists, finance ministers, academics and financial market leaders brings me out in a rash. While the good folks at the Federal Reserve Bank (Fed) of Kansas City like to build it up as something that is closely watched by investors because it often provides important clues about the future direction of monetary policy, the reality is that the chance of something earth shattering coming from it is pretty minimal. But that doesn’t mean we don’t still want to talk about it a lot!!

This year’s version was potentially more keenly watched because it was the first time we would hear from Kevin Warsh as the new head of the Fed. Since taking office at the start of the summer, he has given investors and traders much to think about, not because of what he has said but because of what he hasn’t. He has ushered in a regime where hints, opinions and, most importantly, forward guidance from the Fed post its meetings are going to be kept to a minimum. Because the symposium is less formal, many investors hoped that he would be more forthcoming in terms of winks and nudges.

While his keynote speech answered some of the most pressing questions about how he will form his monetary policy views and communicate them to the outside world, he left many others unresolved. Key wins for investors were that he committed to several key parameters of the Fed’s monetary policy framework and opened up a bit more about how he sees the current economic situation. That alone was enough to shift the market pricing for an increase in the Fed rate in September – it’s still not much better than 50/50 at this stage, but every little helps – and would seem to be a direct response to the near-term inflation risks he sees in the world.

On the other hand, Warsh continued to provide essentially no insight into how he assesses the economic outlook — much less what he thinks the most likely path for monetary policy might be beyond the September Fed meeting. For the past 30 years or so, the conventional wisdom has been that clear communication by policymakers about how they perceive the outlook and the likely future path of the policy rate helps foster more effective monetary policy and enhance central bank accountability. To be fair to Warsh, it is not that he will not be clear on his views around a whole host of factors in the economy, it’s just that he wants to move away from the previous dynamic that had markets being led by the nose with prescriptive guidance on the degree, direction and timing of the next move in interest rates.

The reaction to his speech in Wyoming is probably best characterised as a mix of relief and approval. The optimists will say that it was a sign that he had heard, and taken on board, some of the criticism of his news conference after the July Fed meeting and responded appropriately. Whether that reaction is warranted will depend on whether Warsh views that speech as an aberration, the new normal or the first step in a longer evolution. He is in the office just over 100 days, and this was his first speech; as the saying goes, one swallow doesn’t make a summer!!

As the dust settles and markets return from their summer sojourn post today’s Labor Day celebration, what we can say with certainty is that the Fed’s price-stability objective of 2%, as measured by the personal consumption expenditures (PCE) price index, is a firm, fixed target; it also bears responsibility for maximum employment – therefore achieving both sides of its mandate over the medium term is not an either/or proposition. And perhaps most important – and maybe not what his boss in the White House wants to hear! – short-term interest rates are the predominant tool to achieve the dual mandate. And if that means higher rates to fight inflation, then so be it.

And while he said nothing about his forecast – how he expects the economic situation to evolve over the next year or two – and nothing about what that would imply for the appropriate path of the funds rate, maybe we should just be thankful for what we got and look at the breathtaking views in the wilds of Wyoming rather than a view on interest rates from a yawn-inducing symposium!