Top of the Morning: CIO Strategy Snapshot - Jackson Hole reflections
The desk interprets the recent insights from the Jackson Hole Economic Symposium as signaling a potential tightening ahead if inflation rates do not show sufficient improvement. Per the full note from UBS, Chairman Kevin Warsh emphasized the persistent challenges of inflation, suggesting a hawkish stance from the Federal Reserve should economic data fail to meet expectations. With the August labor market and inflation data slated for release, traders must be vigilant for any signs of change in these narratives that could influence currency movements significantly.
What the desk is arguing
The desk views the remarks from Chairman Warsh at Jackson Hole as indicative of strong potential for future tightening measures by the Federal Reserve. His comments suggest that if inflation does not continue to decline at a satisfactory rate, a shift in monetary policy could be imminent, aligning with our expectation for increased rate sensitivity in the next few months.
Furthermore, Warsh’s dismissal of over-optimism regarding recent economic gains reinforces a cautious approach to future data. Inflation remains a top concern, and should upcoming reports indicate stagnation rather than improvement, markets could react sharply, particularly in the FX space.
Where it sits in our coverage
Our latest consensus target for the USD/EUR pair stands at 1.075, within a range of 1.04 to 1.12. Notable targets from aligned firms are as follows: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This perspective aligns closely with jpmorgan, which expects a similar tightening narrative, while diverging from bofa, suggesting a lower bound outlook that may reflect different views on the inflation trajectory.
How other firms see it
The consensus among aligned firms like jpmorgan suggests agreement on a tightening bias while firms such as bofa prioritize a more dovish stance. This divergence could lead to increased volatility as traders reposition based on new data.
Related currency pairs and indicators to monitor include USD/JPY and the broader impacts of Fed statements regarding future rate decisions, which are likely correlated with inflation metrics and employment statistics.
01Chairman Warsh's remarks suggest potential tightening if inflation fails to improve.
02Focus on upcoming August labor market and inflation data to gauge market reaction.
03Divergences in firm targets signal differing expectations on monetary policy outcomes.
Market implications
Traders should watch the subsequent labor market and inflation releases closely as they could trigger significant movement around the 1.075 level for USD/EUR. Any failure to show improving inflation stats may prompt a reevaluation of positions ahead of potential Fed actions.
Risks to this view
A significantly better-than-expected inflation or labor report could invalidate the current hawkish expectations, leading to a stronger stance from the dollar and reversing the current bearish sentiment on risk assets.
ubs
Hi, everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.
Unofficially, this is the last week of summer going into the Labor Day long weekend, the final chance for investors to enjoy some relative quiet time before the sprint into year end. But it won't necessarily be quiet in the markets as investors continue to digest the latest policy news and first batch of August economic data. So joining us here for the CIO Strategy Snapshot on this Monday morning.
Glad to welcome back from the UBS Chief Investment Office within UBS FSI, Head of Asset Allocation for the Americas Jason Draho. Jason, good Monday morning to you. Welcome back.
Happy Monday. Good to be here. We know summer is coming to an end, Dan, when our audience can't see it, but you're wearing a quarter zip today.
So already preparing for the fall. I don't like it. I don't like it.
I don't like it. There's still a little more summer to go. Well, the seasons do change.
It is what it is. Right, Jason? So last week we were previewing the Jackson Hole Symposium in Wyoming.
We were talking about a lot of anticipation over remarks delivered by Chairman Kevin Moore. So let's focus on that to begin. And we did hear from the chairman on Friday.
Your latest blog is titled Not So Fast, which of course is in reference to Chairman Warsh's speech. I'll ask you simply, Jason, what are your takeaways from the chairman's remarks? Well, there's a couple of things.
First and foremost, I think his message is relatively straightforward. If inflation does not continue to improve at a satisfactory speed, that's his words, then further tightening would become the most likely policy response. He also discounted some of the recent improvement inflation data in the software July labor market report.
Didn't dismiss it, but did not overly emphasize it. By stating that inflation is still a problem and that he would be, again, quote, hard pressed to describe broad financial conditions as restrictive, Warsh's speech I think was undeniably hawkish. He also clearly reiterated that the Fed's target has not changed.
It is 2% on PC inflation. I think there was some concern that he would talk about other inflation measures, how committed is he to that target, and he wanted to reaffirm that. But he also noted that in terms of the inflation picture, that there's a large share of the categories in this PC inflation indicator that continue to experience elevated price growth.
Almost 50% of the components increased at more than 3% annualized rate over the last six months, 54% over the last 12 months. In contrast, pre-COVID, this is roughly a third. So again, there's been improvement, but there's still not enough improvement.
So ultimately, reiterating that we need to see that improvement. If not, we will raise rates. So I think a little more hawkish than expected on that front.
So that was the first takeaway. The second takeaway, and this refers to the title of my blog of Not So Fast, I do wonder if speculative perhaps Warsh read my policy endgame blog from last week. He has to confirm that he did or not, because his speech in some way could also be interpreted as him responding by saying not so fast to this policy endgame scenario.
And if you recall from last week, we discussed it, the policy endgame is this kind of conjecture that monetary policy will eventually have to succumb to financial repression of some sort, because of the US fiscal challenges. With very high debt levels, the debt trajectory to go can get worse and worse, that one way you ultimately have to deal with this is some sort of financial repression, where monetary policy, perhaps in conjunction with fiscal policy, undertakes actions that essentially lower rates. The recent action by the Treasury Department, you kind of the surprise announcement to more than double the size of their treasury buyback program of longer maturity treasuries is interpreted as like, this is a way to try and get rates lower.
You know, again, this is a step in that direction of this, this policy endgame. You know, when the Treasury Secretary Scott Bessett was kind of explaining the rationale for doing that buyback program, he was suggesting that long end interest rates and treasury yields did not reflect economic fundamentals, and therefore, you know, the market signals were incorrect. While Warsh sort of, I say, it's mildly pushed back against that, in his view, this was not a major part of his speech, but I think it was not insignificant, and argue that, again, in quotes, the Fed needs clear market signals as unfiltered as possible, we don't want distortions from the treasury market.
So if you look at that, it's sort of pushing back against this claims and conjectures that, you know, we're on this path towards financial repression, his view was acute, that's not a good thing, we need the market to sort of serve its purpose. So that's the two main takeaways, for the most part, you know, the hawkish message. And then this other part about kind of pushing back against this kind of policy endgame of financial repression.
Did the chairman's remarks, Jason change your expectations for Fed policy as we look through the balance of 26 and into 27? Well, it changed the market expectations in going into it, as of the kind of close of on Thursday, there was about a 35% chance that the market was pricing for a hike in September. That is as Monday morning, it's not 60%.
So you know, sizable increase. But you know, a 60% probability, given that can kind of fluctuate a little bit day to day, to me, it effectively means that the market views September hike as a toss up almost 50 50. And what will determine it really is the data that we get over the next two weeks, you know, the August data for the labor market, the inflation data, I think ultimately, that will determine what the Fed does, we will get the August payrolls data on Friday, September 4, right before the long weekend.
So it'll be people pay attention to it at 830. Then the traders will be out for the weekend. And then we get both PPI and CPI data next week.
So September 10, and 11, again, going into a weekend. It's also the inflation data will occur during the Fed's blackout period. So some of Fed officials could comment on the labor market on Friday.
After that, they kind of go into quiet period until they meet and decide on September 16. If the economic data, the jobs data is in line with expectations, and the current consensus is at 55,000 for nonfarm payrolls. And the core CPI measure measured month over month is in 20 basis points, you know, which was it was around like a little over like 22 basis points for July, if it comes in line with that, it's probably to be sufficient for the Fed to stay on hold at the FOMC meeting.
After that, on September 30, there'll be revisions to the PC inflation data, which will end up kind of reducing some of the hot and written inflation readings from q1 that are embedded into some of these kind of year over year measures. This is due to the way in certain, you know, you know, semiconductor software inflation is measured where the way in which financial services is measured things that are probably reasonable to adjust, but it could take it down by on a year over year basis by 20 or 30 basis points. All these things for us and going back to the question, like, does it change our view?
The short answer is no, we still think the data will come in line that allow the Fed to stay on hold in September, and then continue disinflation trends will keep them on hold. But you think that bar or the line you could say is quite thin between them holding versus hiking. So a month over month print of 30 basis points versus 20 basis points, that could be enough, a job growth that is not 55,000, but 130,000.
And get employment rate ticking down to 4%. Maybe it's because of labor supply, you know, considerations, those factors could get the Fed to say, you know what, we just need to, you know, you know, to hike. But that's so we don't think that will happen.
But it is a getting a pretty close call, which is why the market pricing is close to 5050 at this time. What about the market response, Jason? How did you interpret the market's reaction to the chairman's speech on Friday?
Well, the collective way to interpret is that it's the market prices that have moved against a little bit of debasement trade, or so called debasement trade that's been taking place for a few weeks. In addition to the market pricing for a Fed hike going up from 35 to 60% for September. As a result, the two year treasury yield went up 11 basis points on Friday kind of reflecting the fact that the Fed, you know, may hike, but also hike more in total over the next year and a half to get the inflation lower.
But as you went further on the curve, the 30 year yield, which is really sort of the source of consternation for the treasury for Scott Besant, that only increased one basis point on Friday. So the curve, the treasury yield curve kind of flattened out. Given that the back end of the curve didn't move, you couple that with the US dollar rising kind of on a trading basis by 0.5%.
And then gold fell 3%. All those things would suggest less at the margin, less concern about US policy sort of trying to devalue the base, the currency inflate your way out of this sort of this debt problem. The fact that the 30 year didn't really rise, the dollar strengthened and gold weakened is all consistent with that.
So then you add in the S&P 500 was down 25 basis points for the day. It actually had risen half a percent, you know, kind of by late morning, then the markets kind of gave some of that away. There's obviously other factors that would impact equities more so than it would be for rates in particular or the currency.
But you kind of interpret that as the markets looking like this is not necessarily kind of a bad outcome. But I think that to me is the main takeaway. You know, hawkish, but not to the point of, you know, this is a really negative hawkish tone.
And really it kind of reaffirms, at least for now, some commitment to, you know, avoiding this policy endgame scenario that we discussed. This hawkish shift in Kevin Warsh's messaging, you think about the pushback against the policy endgame. Jason, what do these factors mean for the investment outlook?
Well, I think ultimately not very much, you know, which remains positive. And one could ultimately say that, you know, Warsh's speech kind of, you know, may prove to be actually an incremental positive, you know, for the market. So I'll get into that why.
But I think there are multiple reasons why I think for this assessment for the markets remains constructive. You know, first, you know, Warsh's comments indicate that the Fed is more concerned with, you know, persistently above trend, you know, a target inflation of 2% rather than some sort of short term cyclical inflation. Like it's not looking and thinking the economy is overheating.
It's more like inflation just is kind of stubbornly sticky a little bit above 2%. You know, if that's the case, you know, the Fed is more likely to take an approach that is hikes rates methodically if they do hike rates, rather than sort of looking to aggressively tighten financial conditions with, you know, many kind of rapid rate increases going back to what happened in 2022 and 2023. So that's one thing.
It's, you know, more methodical, more predictable, probably more modest in scope. The second factor is that the market is already pricing for 2.4 hikes by June of 2027. So if the Fed actually does hike even one or two times, somebody doesn't necessarily move the needle that much like they really have to signal we're going to make a much more dramatic increase in policy, you know, to disrupt risk assets because they're already sort of pricing for this scenario.
Third, you know, I think by and large equities, you know, can absorb, you know, rate hikes, you know, within sort of reason, if they reflect kind of good fundamentals, and they're sort of like, you know, again, the pace is more sort of, you know, drawn out. You know, the economic fundamentals are our soul, we saw that in corporate earnings. So again, equities and, you know, credit could withstand that.
A fourth factor is that, you know, AI investment is, you know, kind of boosting earnings across the board. It's having a big impact, you know, for kind of trickling down for many companies in the S&P of 100. This investment story is unlikely to be particularly sensitive to, you know, modestly higher rates, because companies are going to invest, if you this is strategic, long term, sort of importance, almost existential.
If interest rates go up 50 basis points, that's not going to be a reason why, you know, hyperscalers are not investing, they're not going to invest for other reasons. So getting that shouldn't disrupt that dynamic. And then finally, it's a, you know, the Fed will obviously wants inflation, you know, to come down.
But it's probably not at sort of the, you know, the expense of a material higher risks to growth. So kind of, again, sort of fine tuning and we kind of calibrating, maybe taking out some of the insurance from from last year. So I think that's all those factors explain why the markets kind of were like, you know, modestly lower, the equity markets were modestly lower on on Friday.
And ultimately, given those things, if the fundamentals are good, if you just start the feds moving into what the markets already pricing, ultimately, this not really alter overall kind of market investment view of the next six to 12 months. Well, Jason, very timely catch up this morning talking about the outcome of the speech delivered by Chairman Kevin Warsh, what it might mean for monetary policy, how the markets responded, and what this all means for the investment outlook. Thank you again, Jason, for dropping by today.
You're welcome. Have a great week. You as well.
Thank you, Jason. And to you, our listeners out there, I do again want to promote Jason's blog, which we have been covering on today's episode, that title not so fast, which is available now up on UBS.com slash CIO for clients of UBS, simply reach out to your UBS financial advisor to receive a copy of Jason's blog directly from UBS studios. I'm Dan Cassidy.
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