Client Update - 1st September 2023
It is good to be writing to you after a few weeks away, and as always there is much to report. Last week’s Jackson Hole meeting of the US Federal Reserve (Fed) and other leading global central banks, formally known as the Jackson Hole Economic Symposium, is an annual two-day event held in Wyoming. At the event various experts share their forecasts and analyses of the economic and financial outlook for the United States and the meeting aims to provide key insights into the economic challenges faced and how the Fed can address them.
The Jackson Hole Fed meeting has historically been an important event for investors as it can offer clues on potential policy shifts. Last year Fed Chair Jerome Powell announced that price stability was to be the bedrock of the US economy and that the government would do anything necessary to achieve price stability. This harsh language and hawkish tone of further rate rises caused the S&P 500 to fall more than 3% as investors and traders sold off their shares in fear of a tightening of monetary policy.
Last week the focus was on the necessary policy adjustment from reducing inflation to keeping it under control. The rate of price increases has slowed sharply in the US and is moderating in Europe, but Powell and Christine Lagarde, the President of the European Central Bank, were clear that there is still plenty of work to do. Working out exactly when the inflation threat is diminishing is proving hard in the face of unstable supply conditions that continue to affect prices.
Powell pledged that officials would approach future policy decisions “carefully”, suggesting a high bar for the Fed to again raise the federal funds rate at its next meeting in September. Equity markets responded positively to this.
Post Covid, economic analysis requires adjustment to encompass extreme supply shifts ranging from coronavirus lockdowns and fractures in global supply chains to energy supply conflicts following Russia’s invasion of Ukraine. Even in the labour market, the trends are very difficult to assess. When monetary policymakers set interest rates to hit their inflation targets, they must assess where they think demand is relative to supply. Put simply, if demand is estimated to be higher than supply, elevated interest rates help to cool an overheating economy — and vice versa. Economic upheaval, however, makes this calibration significantly harder. Meanwhile ageing demographics and the Artificial Intelligence revolution add more moving parts, with implications for both supply and demand. Powell described rate-setting today as “navigating by the stars under cloudy skies”.
The added problem for central bankers is that interest rates, which impact demand with long and variable lags, are a blunt tool to wield in a time of rapid change. “There is no pre-existing playbook for the situation we are facing today — and so our task is to draw up a new one,” said ECB president Christine Lagarde in her speech. Central banks know they need to adapt but have been slow to do so.
There are some lessons they should heed. First, knowing when, and when not, to place weight on economic models is crucial. Since these are based on historical relationships, they become unreliable in the face of unprecedented events such as Covid, the war in Ukraine and Brexit. Lagarde acknowledged this when she quoted the Danish philosopher Søren Kierkegaard, who said that “life can only be understood backwards; but it must be lived forwards”. Second, central bankers need to update their understanding of supply dynamics. For decades, globalisation has supported flexibility in supply, with free-flowing goods, workers and capital. This trend has started to reverse in post pandemic times and monetary policymakers will need more than just to look back on past trends as the future is unlikely to mirror the past.
An important question remains whether the 2 per cent inflation target central banks are aiming for remains relevant in the long-run. Even then, trying to control inflation with interest rates remains a complicated endeavour. The biggest takeaway from this year’s Jackson Hole ought to be that monetary policy, in its current form, is limited in what it can be expected to achieve and without structural reforms to support supply, volatile prices risk becoming the norm.
Alongside the deemed positive messages from central bankers, data has also softened in recent weeks, meaning there is less chance of further rate rises in the US. US job openings dropped to the lowest level in more than two years in July and fewer Americans quit their positions as they were uncertain that they would be able to secure a new post.
UK shop price inflation fell in August to its lowest level in almost a year, driven by an easing in food cost pressures, according to sector data. The British Retail Consortium published figures on Tuesday that showed the annual rate decelerated to 6.9 per cent in August, down from 8.4 per cent in July and the lowest level since October 2022.
As we move towards the final quarter of 2023, the inflationary regime appears to be shifting and interest rate policy will eventually follow suit. It has been a difficult 18 months for markets, but we see real green shoots of recovery and we may now finally have the worst of the volatility behind us and new opportunities are presenting themselves. We will continue to work hard on your behalf and thank you for the faith and fortitude you have shown. History has shown us that after enduring the difficult times, one must persevere to enjoy the very good times that will undoubtedly be around the corner. Do have a good weekend.