Morning Report: Jackson Hole Week

Vital Statistics:

Stocks are higher this morning as the world’s central bankers head to Jackson Hole. Bonds and MBS are flat.

The upcoming week will be dominated by the Jackson Hole Summit. The two main topics will probably be China’s collapsing real estate bubble and the surprising strength of the US economy. Jerome Powell will speak on Friday.

As far as economic data, we will get existing home sales, new home sales and consumer sentiment.

Jackson Hole summits generally don’t include much in the way of market-moving data, however the long timespan between the July and September FOMC meetings will have investors looking for clues. The general consensus from Street strategists is that Powell’s posture will remain hawkish although he might focus more on dissuading investors from pricing in rate cuts next year than signaling further increases this year.

The 10 year bond yield has picked up 36 basis points since the end of July. Meanwhile, the 2s/10s spread remains highly inverted, although the yield curve has shed some of its inversion, increasing from – 91 bps to -66 bps. Still, on a historical basis the 2s/10s spread is at levels last seen during the early 1980s when Paul Volcker tightened aggressively to conquer 1970s inflation.

I still think the reason for the economy’s resilience in the face of Fed hikes is that even though the Fed began tightening in 2022, real (inflation-adjusted) interest rates didn’t turn positive until the end of the 2022. Even though the Fed was bumping up short term rates, they were still negative, and negative real interest rates are stimulative. In other words, the Fed was still giving the patient shots of adrenaline, just at smaller doses.

In fact, if you look at the Fed Funds rate minus the sticky CPI (ex-food and energy), real interest rates are still negative.

Monetary policy is tight compared to the era of zero percent interest rates, but historically it is still stimulative. The Goldilocks scenario is that inflation returns to normal, and that is possible given the situation in China which is echoing Hemingway’s about going bankrupt gradually then suddenly. The bursting real estate bubble will sap global aggregate demand, and that should be the final nail in COVID-flation.

I think the elephant in the room at Jackson Hole will be China, not US inflation and the concern will be Western banking exposure to a collapsing Chinese real estate market. What will happen to big banks like HSBC, Standard Chartered, Nomura, etc? That will make Silicon Valley Bank look like a tempest in a tea pot.