History Jackson Hole
Since 1978, the Federal Reserve Bank of Kansas City has sponsored a symposium for central bankers. The first conferences were held in Vail and Denver, Colorado. Since 1982, the event has been held in Jackson Hole, Wyoming. Jackson Hole was chosen to entice Fed Chairman Paul Volcker – an avid sports fisherman – to attend as well. The meeting has been held every year since then at the Jackson Lake Lodge in Grand Teton National Park, a part of the United States that we seem to know primarily from the painter Bob Ross, an almost surreal world of snow-capped peaks, trees, and lakes. Furthermore, Jackson Hole is known for winter sports, especially powder snow. Unfortunately for central bankers, due to the corona crisis, the meeting has been virtual since last year.
Monetary policy is made in Jackson Hole
The Jackson Hole meeting is an ideal place to release trial balloons, things that could later make a significant turn in monetary policy. One of the highlights each year is the Fed chairman’s speech, as several presidents have used this moment to announce new policies. This year, Jerome Powell gets to speak on Friday morning, August 28. The central theme this year is when the Fed will tapering. Tapering is the gradual reduction and eventual cessation of monthly purchases.
This is not the first time the Fed has been tapering. Central bank bond buying may fall under the heading of unconventional policy, but in practice, this unconventional policy has been used for more than a decade. The last time the Fed began tapering was in December 2013. Then the Fed reduced monthly purchases from $85 billion per month to $75 billion per month. That caused the 10-year U.S. interest rate to rise from 1.5 percent to 3 percent. Currently, the Fed buys 120 billion in bonds each month and the ten-year interest rate stands at 1.25 percent. In 2013, tapering caused a lot of turmoil. The Fed is trying to avoid that this time. The Fed’s latest minutes already indicated that most members of the Federal Open Market Committee (FOMC) favor starting tapering in 2021, provided the economy is strong enough. The minutes literally read, “most participants noted that, provided that the economy was to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year.”
Tapering should not surprise
Various members of the Fed (San Francisco, Atlanta, Boston, Richmond, and Dallas) have also given speeches in recent weeks that should ensure that the actual announcement of tapering should no longer come as a shock to financial markets. Until recently, markets were still counting on tapering starting in the course of 2022. This has now been brought forward by a few months. US interest rates have not contracted in the meantime. This is also because the start of tapering seems to coincide with some slowdown in growth caused by the delta virus and shortages of chips and other components. But in financial markets, something may not be a problem for a long time until it is, and Jackson Hole has been a tipping point before.
Fed reacts much later than usual
The 120 billion in monthly buybacks consists of 80 billion in government bonds (treasuries) and 40 billion in mortgage-backed securities (MBS). As a result, U.S. mortgage rates are at historic lows and house prices have risen sharply over the past twelve months. Stimulating the housing market is no longer necessary. Also, it is unprecedented in the past for the Fed to pursue such an extreme policy of stimulus when inflation is so high – it has been above 5 percent for two months now. But since last year’s Jackson Hole meeting, the U.S. central bank’s policy has changed. The Fed now aims for a long-term average inflation rate of 2 percent. That inflation has moved below 2 percent for so long that it is now allowed to rise above 2 percent for an extended period of time to return to trend. With inflation above 5 percent, things do move quickly. Accrued inflation has already compensated for the last five years, and soon the under-inflation of the last 15 years seems to have evened out. That is even before the start of unconventional policies in the United States.
Interest rates are important for the valuation of financial assets
The U.S. interest rate has a major impact on the valuation of the stock market. With historically low-interest rates, even U.S. stocks look attractive in terms of valuation. The ten-year interest rate in the United States rose from 0.75 percent in December to 1.75 percent in March. Since then, the interest rate has fallen to 1.25 percent. It is unprecedented in U.S. history for government bond yields to be below 2 percent for so long. Even at 2.5 percent, the compensation that equities offer over and above the risk-free rate is still attractive. Consider further that today’s central bankers would rather be late than early. Inflation has to rise, and it has to rise to a level that minimizes the chance of another flirtation with deflation. Furthermore, central bankers are also leaning more and more toward the Keynesian school and neoliberal monetarism seems to have fallen by the wayside. Moreover, central bankers have multiple goals, not only economic but also social. For example, the ECB is committed to the energy transition and Powell is striving for a job for every American, regardless of ethnic background.
Financial stability puts a floor under the market
Another goal of central bankers today is to guard financial stability. This focus has to do with high debt levels. Financial turmoil can quickly create a new debt crisis through these debts. In fact, central bankers are telling stocks not to fall fast and this fact lays a floor under the market. Due to the extensive communication from the Fed about tapering and the unwarranted fear of a repeat of last time’s turmoil, it seems that this round of tapering will be much smoother than the last. That means that many investors will realize that interest rates could remain relatively low for an extended period of time, while inflation is above average. Not an attractive prospect for savers and bond investors. For years the inflow into bonds was greater than the money flowing into the stock market. This has changed this year. There is even talk of a rotation from bonds to equities, also seen by some as the great rotation. Such a rotation means that even without further monetary and economic impulses, the stock market can continue to rise.