Making Jackson Hole great again – even if the speech is virtual. Jerome Powell, Chairman of the Federal Reserve, will be addressing the forum and markets are at the edge of their seats.
The topic is “Monetary Policy Framework Review.” The Chair is set to announce a change to how the bank tackles inflation – after failure to boost price rises for years. The market movement has been limited in anticipation of the critical speech and volatility is set to explode.
How will the dollar and stocks react? Here are three scenarios.
1) Announcing AIT – moderate dollar decline
Investors expect Powell to announce Average Inflation Targeting (AIT) – allowing prices to run faster in one year or more, to compensate for slow inflation in the past. That means keeping interest rates lower for longer and thus weighing on the dollar.
While pundits have been discussing this option for weeks, the dollar has yet to fully price the development. Powell recently said that he is “not even thinking of thinking of raising rates” – signaling no hikes at least until 2022 due to the coronavirus crisis.
Nevertheless, allowing inflation to run higher for longer than the next two years means long-term bond yields – such as the benchmark ten-year Treasury – could suffer another slide, consequently making the dollar less attractive.
Powell may say that details of the new framework will be laid out in the upcoming Fed decision in mid-September, leaving markets to speculate that inflation of just above 2% would be satisfactory.
This scenario, which has a high probability, means an initial choppy reaction and a more moderate dollar decline afterward. For stocks, it would be supportive, but equities will likely return to focusing on economic data, politics, and other topics.
2) Diving into details – detrimental to the dollar
The “holy grail” of central banks is 2% annual inflation – something the Fed has fallen short of during most of the post-2008 period. The Jackson Hole Symposium is an academic conference and Powell may delve into details of the new policy.
If he says that Fed would tolerate around 3% inflation per year – a substantial shift to the policy since the early 1980s – the dollar would crash. Investors are expecting only 2.25% or 2.50%. As mentioned earlier, price development is slow and a long recovery from COVID-19 means pressures are unlikely to rise in the short-term.
However, assuring investors that the Fed’s zero rates are a long-term proposition would boost stocks, giving them a considerable jolt to the upside.
This scenario has a medium probability – there is a higher chance that Powell will wait for Fed’s September meeting and refrain from numbers.
3) No imminent announcement – greenback comeback
Taking the academic, scientific approach, could also mean only theoretical talk – raising various options to change policy without committing to anything. The chances are low as Powell previously seemed eager to conclude the policy review and move on.
In this case, investors would be disappointed that there is no additional oomph. Without a long-term commitment to zero rates, yields could rise and the dollar would follow. Such a non-event would deal a blow to stocks. While equities have shown their ability to recover – Powell could trigger a much-needed downside correction.
Conclusion
Powell’s consequential speech is set to rock markets and the more details he provides to the new policy – most probably allowing inflation to run high – the better for stocks and the worse for the dollar.
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