Market Analysis

The Overlooked Lessons at Jackson Hole

What we think investors should and shouldn’t take away from US Fed Chair Jerome Powell’s speech at Jackson Hole.

US Federal Reserve (Fed) Chair Jerome Powell virtually delivered his much-anticipated speech at the Kansas City Fed’s annual Jackson Hole monetary policy party last Friday. As many observers we follow expected, he pretty overtly hinted the Fed is heading towards slowing quantitative easing (QE) asset purchases—i.e., tapering—this year. Loads of financial commentators we follow see QE as crucial fuel for equities and the economy, and many have hyped this proclamation as a watershed moment. But, no shock to us, the news didn’t seem to faze markets one bit. In our view, this further demonstrates the near-constant coverage of the Fed and other monetary policy institutions common in financial publications we cover is overdone. In our view, the Fed, Bank of England (BoE) and other monetary policy institutions simply aren’t as powerful as many believe—worth remembering amidst calls to give them even more responsibilities.

In past communications, the Fed has tied changes to monetary policy to the state of the US economic recovery. Powell often referred to the need for “substantial further progress” in things like lowering the unemployment rate before even considering any adjustments.[i] His Friday speech implies that hazy distinction has been hit, with most coverage we read focusing on this particular section:

My view is that the ‘substantial further progress’ test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC's recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.[ii]

In the purposefully vague and nebulous communication we have found monetary officials use—what we refer to as Fedspeak—this is about as clear a taper signal as you will get. The market reaction, though, amounted to a yawn. 10-year US Treasury yields ticked down to 1.31% from 1.34% whilst US shares rose 0.9% on the day, closing at a fresh record high.[iii]

Based on our research, most fixation on Powell’s Jackson Hole speech stems from the bizarre notion equities’ rise since late-March 2020 was due largely to Fed action—particularly QE. This isn’t just a US phenomenon—our coverage of financial headlines globally suggests this view is widely held in the UK and Europe, too. For example, we saw some commentators interpret the BoE’s latest guidance as a taper template—and question whether it was wise to deploy it. In our view, though, monetary officials’ market influence is vastly overstated. QE isn’t the economic boost many presume—in our view, it is an economic sedative, not stimulant. Banks’ core business model is to borrow at short-term rates (e.g., what they pay depositors) and lend at long-term rates (e.g., business, personal or mortgage loans). Monetary authorities’ buying long-term debt lowers long-term interest rates, and with short-term rates already near zero—or even below zero in the European Central Bank’s (ECB) case—the result is a smaller gap. That implies lending is less profitable, and based on our study of economic history, that discourages banks from taking on the risk of making loans. That weighs on loan growth, which is the primary way money enters the economy and fuels growth in fractional reserve banking systems like the US, UK and eurozone.

In our view, markets’ non-reaction shouldn’t shock. Even if you disagree with our QE views, monetary officials’ words routinely receive public scrutiny from widely followed commentators. We think efficient markets have heard taper chatter since the year’s start—noise that has only increased lately. We think those taper discussions sapped surprise power by the time Powell delivered his address on Friday—markets, which abundant research shows are forward-looking, likely already reflected the information.

In our view, the obsession with monetary policymakers has lately spun even more out of control—in ways that risk politicising monetary policy. For example, some experts we follow think monetary officials should account for climate change in crafting monetary policy. Fed Governor Lael Brainard addressed the topic in a March speech, positing climate change could increase financial system vulnerabilities—necessitating Fed investment in research and tools to address the potential risks.[iv] The BoE has regularly discussed addressing climate change since former-Governor Mark Carney’s term.[v] In Europe, the ECB paid lip service to fighting climate change following its recent monetary policy strategy review.

But expanding monetary authorities’ responsibilities has more downside than upside, in our view. Take the Fed, which was created initially to serve as lender of last resort to banks in a crisis. The US Congress added a dual mandate—to foster maximum employment and stable inflation—in the 1970s, after former President Richard Nixon was revealed to have strong-armed former Fed Chair Arthur Burns into holding interest rates artificially low early in the decade, which our research shows contributed to high inflation. But the Fed’s record on achieving these measures isn’t stellar. In our view, it failed to act as lender of last resort amidst bank runs in 2008. After announcing an inflation target of 2% y/y in 2012, the Fed spent the next eight years largely undershooting it before revising the target last August.[vi] Moreover, the Fed lacks a crystal ball. As transcripts from 2008 Federal Open Market Committee meetings show, most Fed officials completely missed diagnosing the financial crisis. Just two weeks after Fed decisions forced Lehman Brothers to fail (based on our reading of the transcripts of the relevant meeting), former Fed Chair Janet Yellen—then San Francisco Fed President—joked about the recession’s chief effects being dwindling country club memberships and deferred plastic surgeries.[vii] Fed governors closed that gathering debating whether their policy statement should characterise them as watching economic developments “closely” versus “carefully.”[viii] In our view, they seemed broadly unaware the worst financial panic since the 1930s was underway.

Given their ineffectiveness with hitting inflation targets and economic outlooks, why add another target—especially one far removed from their traditional purview? Knowledge of climate science, itself an evolving field, isn’t in a monetary policymaker’s wheelhouse, last we checked. Nor is knowledge of the various technological solutions to emissions and electricity generation. It also isn’t clear how monetary policymakers’ actions could impact the environment or climate. Their tools are designed to address monetary conditions that have a downstream impact on macroeconomic conditions. They lack tools to address things at a sectoral or industry level directly, even if they wanted to.

Some suggest the Fed and other monetary policy institutions should add environmental criteria for potential QE asset purchases or future policy actions—meaning it wouldn’t buy debt securities from firms like fossil fuel producers. We have seen many experts argue this would make those firms’ funding more costly—and curtail their ability to expand production, etc.—unless they went greener. But this implies the Fed and its brethren are the market’s most important participant—a fallacy, in our view. Even if monetary policymakers decide to favour a certain industry or sector, the losers won’t necessarily be cut off from markets, in our experience. As yields rise, private investors may see a buying opportunity and step in, offsetting that pressure.

Regardless of the practical impact (or lack thereof), we think this would look like unelected officials picking winners and losers. That is elected politicians’ stock and trade. The more monetary policymakers pursue these kinds of measures, the more they invite political interference. We think that is dangerous. Revisit the Nixon-era lessons. The Fed has never been totally independent, but it generally has enough freedom to implement policy without worrying about what it does to politician XYZ’s election chances. The more it injects political choices into policy, the less likely that holds in the future, in our view.

There is no clear sign the Fed or other monetary policy institutions will add politicised factors to its purview. But we generally subscribe to Occam’s razor—simpler is often better. We fail to see how adding more complexity to monetary policymakers’ jobs would lead to better monetary policy.

[i] “The Fed Hinted It Could Reconsider Easy Policies if Economy Continues Rapid Improvement,” Jeff Cox, CNBC, 19/5/2021.

[ii] “Monetary Policy in the Time of COVID,” Fed Chair Jerome H. Powell, US Federal Reserve, 27/8/2021.

[iii] Source: FactSet, as of 27/8/2021. US 10-year Treasury yield and S&P 500 price return on 27/8/2021. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.

[iv] “Financial Stability Implications of Climate Change,” Governor Lael Brainard, US Federal Reserve, 23/3/2021.

[v] “Bank of England Chief Mark Carney Issues Climate Change Warning,” Roger Harrabin, BBC, 30/12/2019.

[vi] Source: Federal Reserve Bank of St. Louis, as of 30/8/2021. Statement based on US Personal consumption expenditures price index, January 2012 – August 2020.

[vii] “Meeting of the Federal Open Market Committee on September 16, 2008,” US Federal Reserve, 16/8/2008.

[viii] Ibid.

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