No one knows for sure what Chair Jerome Powell will say in his speech on Federal Reserve monetary policy Friday. One thing is clear, though: the potential for marketwide shock is sky high.
Stocks, bonds, commodities -- everything is moving in lockstep, their unified swings turning almost exclusively on views as to whether the central bank will cause a recession. The obsession with economic data and remarks by Fed officials have driven a measure of cross-asset correlation tracked by Barclays Plc to almost double, putting it among the highest levels of the past 17 years.
Heading into the Jackson Hole symposium, where Powell is expected to restate his resolve to keep tightening monetary policy to fight inflation, investor sentiment has been shifting. Equities and fixed income just staged their worst concerted selloff since June, after spending much of the previous two months in a rally mode.
Stakes are rising. Hedge funds, for instance, are building massive bearish positions against both assets in the futures market, a sign that bears may be gearing up for a hawkish message.
“Powell has been such a wild card in his communication that who knows exactly what he’ll deliver. So you need to be nimble and prepared to respond either way,” said Steve Chiavarone, a fund manager at Federated Hermes. “This is a macro-driven market.”
Across assets, the utmost focus is the trajectory of inflation and the Fed’s plan to tackle it. With the central bank embarking on the most aggressive hiking cycle in decades, Treasuries have seen their status as a safe haven shaken. The swift rise and fall in yields -- putting 2022 on track for the most violent year in more than a decade -- have become a source of market stress, at times forcing investors to rein in risk appetite.
Coinciding with heightened volatility, market moves have rarely been so in sync. Tracking 12 exchange-traded funds across regions and asset class, Barclays found that their six-month correlation has increased to 0.34 from 0.19 earlier this year. (A reading of 1 means they’re moving in unison.)
The firm also discovered anomalies when compared with past central-bank gatherings at Jackson Hole. Markets that historically are least sensitive to the event, such as equities and credit, are pricing in larger implied moves in the options market, signs of caution. Meanwhile, government bonds, those more sensitive to policy changes, are less troubled.
The “discordance turns Jackson Hole playbook upside down,” Barclays strategists including Stefano Pascale wrote in a note this week. “Risky assets face a reality check.”
Powell’s speech at the two-day conference in Wyoming will be parsed for clues on how much further the Fed will go with its monetary tightening. Despite repeated warnings of late from policy makers that their battle against inflation is far from over, investors have mostly been undeterred from their conviction that a pause or a reversal in rate hikes is on the horizon.
Right around the Fed’s decision to hike rates by 75 basis points in mid-June, stocks and bonds started a synchronized rally, contributing to an easing in financial conditions that is at odds to what central bankers aim to achieve: Let higher rates and lower asset prices temper overheated demand.
In some way, it’s perhaps the market doubting the Fed’s ability to correctly forecast the economy. One year ago at Jackson Hole, Powell stuck to the central bank’s message that the bout of inflation was likely to be transitory, an assessment that turned out to be wrong.
While Powell will try to reset market expectations, Marko Kolanovic, JPMorgan Chase & Co.’s chief global markets strategist, is skeptical that the Fed will be able to stick to its hawkish path for long. In his view, raging inflation, driven by the commodity supercycle and the Covid recovery, would recede naturally as time passes by.
“We maintain that inflation will resolve on its own as distortions fade, and likely drive a Fed pivot,” Kolanovic wrote in a note this week. “In Chair Powell’s remarks at this week’s Jackson Hole conference, we do not expect him to tip his hand on the size of the next move, which will depend on upcoming releases, but we believe he will push back against the idea that a dovish policy pivot is coming soon.”
Granted, the post-COVID era is next to impossible to forecast. A serious recession or a soft landing? No one can predict with high confidence. With the range of outcomes so wide, many money managers trimmed market exposure and parked money in cash.
“Jackson Hole is supposed to be this deep-thinking, big-idea thing and should not be market moving,” said Fred Goodwin, a strategist at State Street Global Markets. “But hey, we are in post-pandemic world, inflation is nuts, policy is tightening like crazy, making investors nervous.”
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