Trader Warns Jackson Hole's "Hesitantly Optimistic" Chatter Will Be "Nothing But Buying Time"

Hawkish, dovish, hawkish, dovish? As many market participants suspect, this week"s Jackson Hole "retreat" wil be a nothing-burger with perhaps a side-dish of temporary volatility as machines quibble over various words in headlines. Former fund manager Richard Breslow warns not to expect much...

Via Bloomberg,

Expect to Hear Jackson Hole Is Great in August

At some level, I hope I’m wrong. This week would end up being far more interesting if we do indeed get some juicy policy announcement out of one, or, why not be greedy, two, of the big kahunas headlining Jackson Hole. But it’s unlikely and markets may well end up having to figure out what they want to do between now and autumn on their own.

As much as these folks love to talk, they probably have little intention of communicating.

What do we know?

The Fed doesn’t pre-commit. But has essentially done so on a taper announcement and commencement in the fall. Their best laid plans call for as benign a start to this process as possible. Whether Chair Yellen mentions it again is largely irrelevant. They want to do it and think they can. And they won’t if something untoward happens.

If her base case is transitory inflation and one more hike this year, this is neutral not hawkish. Or I should say uninformative. Their first priority is balance sheet and rates after. A hike requires waiting to see inflation numbers tick up. We’re going to know nothing new on this subject before the Aug. 31 release, at the earliest, of the PCE deflator.

President Draghi’s notion on timing of a taper has to be influenced by the German election. And that comes after the ECB’s September meeting. The Chancellor’s re-election is widely assumed. But peace and harmony within the Zone will be the order of the day until it is over. Periphery spreads are still tight but have begun to show signs of widening out. Another 10 basis points wider in the BTP to bund spread and things begin to look interesting.

The ECB has a much harder task than the Fed in pulling back stimulus due to the structure of the PSPP and use of the capital key. Confidently dismissing the process as harmless for markets is a luxury they can’t indulge in.

Of course, if the market "misinterprets" anything (translation - sells off), there are numerous officials willing and able to step into the breach and save the world with some clarifying "that"s not what he/she meant" remark. As Breslow concludes, we have all got rather used to it...

Unfortunately, there are the speeches and then the chit chats. With all of the winks, spins and low-downs we’ve come to expect. So, no matter what is said from the podium, expect to be treated to no end of assurances as to what they really meant.

In truth, they’re buying time, hesitantly optimistic and have a plan that sounds great in theory.

The Fed Has An Alarming Low-Inflation Problem

With all the talk of central bank hawkishness in the last week, one might assume there was some inflation to point to. It is quite the opposite. It is one thing to talk about inflation being below the Fed’s target of 2%, it is an entirely different issue to see it flirting with deflation! Shorter-term trends of core-inflation are very near to 0%, levels we haven’t seen since the great recession and the advent of quantitative easing.

In its most common form, inflation is quoted by measuring its percentage change compared its level 12 months ago, the so-called year-over-year (YoY%) metric. But, shorter-term periods can be measured to get a sense of more recent trends as well as if there is acceleration or deceleration in the metric. The shorter the period measured, the more volatility the metric has, and so year-over-year (YoY%) has become the standard. It also has the added benefit of eliminating any seasonal effects.

In the charts below, we show the two top-tier measures of consumer price inflation, the Fed-preferred core PCE deflator, and the core CPI; with its common year-over year (YoY%) format, 6 months back annualized, and 3 months back annualized. Comparing the three gives a sense of acceleration of deceleration. If the 3mo. is less than the 6mo. is less than the 12mo., there is deceleration and vice-versa, there is acceleration.

 

But, beyond these charts, evidence of low inflation abounds. The headline versions of these numbers (including oil and food) are negative over the last three months, the ‘prices paid’ component of the manufacturing ISM number fell by a large amount in a release on Monday (7/3), the ‘prices paid’ component of the Service-sector ISM is now contracting, inflation expectations in all indicators have been falling since February, and the OECD published a report yesterday (7/4) that the inflation rate has fallen for four straight months in G-20 economies.

Despite the excitement last week at the prospect of global central banks moving away from easy money policies, there is no fundamental basis for this. We expect that the Fed will soon need to move to a neutral from tightening bias.

Trader Warns: Fed Rate Hike Will Be The "Death Knell" For Reflation Trades

Thanks to commodities, Bloomberg"s Mark Cudmore warns that the Fed meeting is more likely to be the death knell for reflation trades rather than mark their moment of victory.

This week is set to provide confirmation that we’re in the midst of a true tightening cycle in the U.S., with rate hikes in consecutive quarters for the first time since 2006.

10-year Treasury yields hover just below the two-year high, but I don’t see them breaking higher in an environment where commodity prices are plunging.

Oil was just the latest victim last week, with prices falling the most in four months. The broader Bloomberg Commodity Index topped out a month ago, with everything from metals to agricultural goods turning sharply lower since then.

This undermines the reflation trade in three ways.

1. Most directly, it’s hard for inflation to keep accelerating when input prices are slumping.


2. It also suggests that real demand is not growing as quickly as hoped, which provides caution on economic optimism.


3. Finally, while cheaper commodity prices are a long-term positive for economic growth, the more immediate wealth/portfolio effect is negative.

Price data from the U.S. this month has validated the suspicion that inflation is not rising as fast as forecast, with the PCE deflator coming in below expectations.

This isn’t an environment that supports much higher long- term yields. Add in the context that speculative short positions in Treasuries remain near record levels and it appears to be a market ripe for a squeeze.

Furthermore, as Bloomberg"s Richard Breslow concludes:

The abrupt about-face by the Fed has dealt a severe blow to the efficacy of forward guidance.

Markets will understandably assume that central banks are now using commentary as a tactical device to control the moment rather than a way of describing a strategic plan based on long-term forecasts.

It means we are in for a lot more false steps, conspiracy theories and greater volatility