The big event of the month is here!
Central bankers from around the world convene for the annual Jackson Hole symposium (by convene, I unfortunately mean get together via videoconference due to Covid-19 travel restrictions).
Bank of Canada Governor Macklem and Bank of England Governor Bailey are both slated to speak. The former bank is currently conducting a review of its monetary policy framework, and so CAD traders will be interested to hear how this is going and any conclusion the BoC might have arrived at (such as average inflation targeting, which some BoC members have hinted is an option).
Meanwhile the BoE is conducting a review on the efficacy of negative rates; GBP traders will be intrigued to see how this review is going (if the BoE are going to go negative, this is a big GBP negative, while if they conclude against negative rates, this removes a risk to GBP and thus should be taken as a positive).
While these two speakers will be interesting, Fed Chair Jerome Powell will steal the limelight. Speaking at 1410BST/0910EDT tomorrow, he is expected to speak on the Fed’s ongoing Monetary Policy Framework Review which started back at the start of the year, incidentally prior to the Covid-19 pandemic’s global spread.
The review is scheduled to finish in September (with the full results of the review expected to be announced at the September FOMC meeting). Some have suggested that Powell might disappoint and keep everyone waiting for the key conclusions of the review until September. Most, however, suspect he will at least partially allude to the review’s conclusions.
Much has changed since the start of the framework review; Covid-19 triggered global lockdowns, which prompted the Fed to cut rates to just above 0.0% and unleash limitless QE, liquidity and direct to business lending programmes.
But a key pre-Covid-19 issue remains unsolved; in this recovery, how can the Fed avoid inflation persistently undershooting the 2% target like it did for most of the last decade. During the post-global financial crisis recovery post-2009, the Fed has concluded that “financial conditions” (pretty much, market expectations about future interest rates) tightened too quickly as the economy began to recovery.
This time around, the Fed wants to ensure that markets don’t start immediately betting on higher interest rates the second the economy starts looking like it is getting back to its pre-Covid-19 health. Rather, the Fed want to let easy financial conditions continue for quite some time to foster a faster, longer recovery.
Therefore, the Fed has signalled that the key here is to provide the market with “better” forward guidance – as in, assurance that rates will be low and monetary policy accommodative for a long-time.
How can they do this?
Various different ideas are being thrown around by various banks, but the FOMC is widely expected to adopt some combination of outcome based forward guidance, calendar based forward guidance, average inflation targeting or yield curve control;
Outcome based forward guidance – This is where the Fed would, for example, say “we will not hike until unemployment is back below 5%”.
Calendar based forward guidance – This is where the Fed would, for example, say “we will not hike until 2023 at the earliest”.
Average inflation targeting (AIT) – This is where the Fed would explicitly state that it is willing to tolerate above target inflation for a few years to compensate for a near decade of below target inflation.
Yield Curve Control – This is where the Fed would say to markets that it will not allow US government bond yields to rise above x%, and will buy limitless sums of them to ensure this in the meantime.
Fed officials have already pushed back against this latter option. But the first three are all still very much in the ball park. AIT is seen as the most dovish option, and if Powell signals a move towards AIT tomorrow, this would be the most USD negative, risk asset positive outcome.
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