Jackson Hole review

Kevin Warsh’s much-anticipated speech at Jackson Hole was a break from the past; as expected there was no forward guidance. We did not get prepped about any future rate hike, and the markets can’t seem to agree on what his message was. Stocks are acting like he was dovish, while gold, the dollar and bonds are all acting like his speech was hawkish. One thing Warsh did achieve today was to confuse financial markets.  

Warsh does not give away rate stance 

The key takeaway from his speech is that the Federal Reserve remains in inflation-fighting mode. Although Warsh does not provide forward guidance, he noted that in his view financial conditions are not tight, although the US 30-year Treasury yield is at a near 2-decade high. However, this does not mean that rates need to rise, or that he will vote for a rate hike at next month’s Fed meeting. 

Warsh uncomfortable with inflation above target 

Warsh maintained his focus on the direction of underlying inflation and the Fed’s 2% inflation mandate. Although cost pressures remained steady in July, the Fed’s preferred measure of inflation, core PCE, is still well above target at 3.3%, which is obviously an uncomfortable state of affairs for the Fed chair. 

Hawkish response from bond market and gold 

The market reaction has been immediate. Treasury yields have jumped sharply and are higher by 6bps for 2-year Treasury yields. The 10-year yield is down 1bp, as the US yield curve flattens in response to Warsh’s speech. 

The focus on inflation has also knocked interest for gold. The gold price is currently lower by 1.2% and is testing the $4,600 level. Gold is an inflation hedge, so it tends to underperform when the Fed is in inflation-fighting mode. The next major support zone is $4,538, the 200-day sma, as you can see below. 

GBP gets another pounding after Warsh speech 

The dollar index has also been given a boost by Warsh, and is the top performing major currency on Friday, and is higher by 0.3%. The biggest losers on the forex front include EUR/USD and GBP/USD, which are both lower by more than 0.3% on Friday. GBP/USD is back below $1.3450, and the pound is the weakest currency in the G7 this week, and has declined by 0.6%. 

Stock markets are unconcerned by Warsh and his inflation fixation 

Warsh’s speech comes at an auspicious time, we are moving into September, which is traditionally the weakest month for equities. US stock indices had a mixed reaction to Warsh’s speech. The Dow Jones and the S&P 500 eked out a gain and were the most resilient, while the tech sector sold off slightly, and there were mild losses for the Nasdaq and the Russell 2000. 

Traders book Nvidia profits 

Tech weakness on Friday may not be directly related to Warsh’s speech, and more a function of profit taking after Thursday’s blistering rally in the AI trade and in software stocks. Traders are booking profits in Nvidia as we end the week, and the stock price is lower by 1% on Friday, after an 8% rally on Thursday. Salesforce had its best ever daily performance on Thursday, and the good news is not over yet. It is higher by a further 3% on Friday, suggesting that software stocks could narrow the performance gap with chip stocks in the coming weeks. 

Stock traders vs. Bond traders

It is hard to surmise the market reaction to Warsh’s speech. The stock market is acting like his speech was dovish, and US indices are not pricing in a near-term rate hike from the Fed. However, the interest rate futures market is pricing in an increased chance of a September rate hike. Expectations for a hike have jumped to just over 40% from 35% before his speech, after Warsh said that the Fed cannot afford for inflation expectations to become de-anchored. This suggests that the Fed will continue to focus more on inflation than any more weakness in the labour market. 

‘Dollar Alt’ trade loses its lustre after Warsh 

Stock markets have not had a major reaction to the speech, and are brushing off the increasing prospect of a rate increase from the Fed. Instead, the main reaction has been a weaker gold price, and a stronger dollar. Bitcoin has also dropped below $79,000 as the ‘Dollar Alt’ trade loses its lustre. We think that this theme could continue as we move into September. 

Chart 1: The gold price dives after Warsh speech 

Source: XTB