One week / one topic: Fessing up

What happened?

Jackson Hole, Wyoming is a beautiful place. Go visit.

Every year, central bankers gather here for a three-day economic symposium to discuss long-term policy issues “of mutual concern”.

Let’s just say that – in recent years – there’s been plenty to discuss, as we all grapple with huge shifts in the overall macro picture.

Pandemics, runaway inflation, wars, unrest, digital gods… we’ve got you covered.

Recently installed Fed Chairman Kevin Warsh – after his ‘let’s say very little’ communication style spectacularly backfired, twice already in the space of a few weeks – was never going to miss this opportunity to say something.

Lo and behold, Warsh mapped out the key data points he uses to read the US economy… which – ahem – is kind of the whole job?

As per his remarks:

• Business investment: The “the seed corn of future economic growth” is growing at 9% thanks to the AI capex boom, with the economy’s supply side genuinely expanding.

• Corporate earnings: S&P 500 profits are up more than 20% over the past year along with record margins. Yay!

• Credit: Very low corporate and leveraged-loan spreads signal that lending standards remain quite accommodative.

• Consumer spending is showing private domestic final purchases (i.e. stripping out government, inventories and trade) up almost 3% this year.

• Jobs: The labor market remains ‘quite stable’ and consistent with full employment, along with soft payroll growth

But – as we all know – the real problem remains inflation, with core PCE (Personal Consumption Expenditures index) still too high at 3.3%.

Meanwhile, inflation expectations remain somehow anchored, giving the Fed comfort hope that all is not lost after all.

That said, real yields have massively shot up (taking nominal yields along for the ride) and financing huge deficits is increasingly challenging, even if in theory this should not directly concern the Fed…

While missing the Fed’s own inflation target for five years straight might have forced Warsh to spell out what he is looking at, he still told us nothing about where he thinks the economy and the Fed funds rate go from here.

An old saying comes to mind, then: “You need to listen carefully to hear what is not being said”.

And so, what is not being said here?

Our observations

• Fundamentals: Judging from the recent global bond selloff, investors very much think that we have shifted from a disinflationary world of bond bubbles and QE to an inflationary “new normal” of heavy issuance, AI-hungry capital demand and central banks selling rather than buying.

• Price action: Yields have risen broadly across regions and tenors, yet in a relatively smooth manner.

  While the nature of the move does not scream ‘panic!’, we are sitting a multi-year highs in yields across the board.

• Investor beliefs: Bonds implied volatility remains relatively low, which might look surprising given how far we’ve travelled.

  Perhaps this is a tell that investors have accepted this as a new regime, as opposed to an accident that you should try to fade?

So what?

Under duress, Warsh has finally told us something and showed his tools of the trade, which largely read: “Growth is fine, inflation still isn’t”.

The real tell, however, is that he felt compelled to state the following: "The Fed's price-stability objective of 2 percent, as measured by the personal consumption expenditures (PCE) price index, is a firm, fixed target."

If markets already thought that that was the case, he wouldn’t feel the need to say it out loud… would he?

In the end, the combination of a nervous Fed + interventionist Treasury + erratic executive doesn’t really inspire a lot of confidence.

As a result – while recognizing that government bonds might be doing what they are supposed to, i.e. paying you to wait – I am not sure that the income cushion is enough (yet) to make this ‘new normal’ entirely tolerable.

Central banks still have a lot to do to regain credibility, and in the event of a true growth shock – which would also inevitably trigger massive fiscal stabilization – the portfolio insurance properties of government bonds could be significantly impaired.

Mood music: Sorry Seems To Be The Hardest Word – Elton John

By popular demand, here is the One week / One topic playlist

The information provided should not be considered a recommendation to purchase or sell any particular security.