Week Ended Aug 27th, 2021:Fed strikes dovish tone
It was another rather sleepy summer week in financial markets which lacked moves either way with conviction, that is until Friday. During the week, most eyes were focused on the lead up to the virtual Jackson Hole economic symposium of central bankers on Friday so that investors could better understand the likely path of the Federal Reserve’s stimulus unwind. In essence, Federal Chairman Powell’s speech at the symposium was deemed slightly more dovish than anticipated, and this buoyed financial markets. You can find Chairman Powell’s statement from the symposium on the Federal Reserve website here, and if you prefer, can watch it on YouTube here. Below are extracts towards the end of the speech that capture the Fed’s tone at the moment:
“We [the Federal Reserve] have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the "substantial further progress" test has been met for inflation. There has also been clear progress toward maximum employment.……. The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test. We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time. We have much ground to cover to reach maximum employment, and time will tell whether we have reached 2 percent inflation on a sustainable basis.”
The media is suggesting that Chairman Powell is the most dovish member of the Federal Reserve, but the only part of the speech as far as future policy steps that did not perhaps align with what was expected is the Fed’s caution in the second phase of the tightening exercise, which is raising short-term rates once tapering is completed. I agree with most economists that tapering is likely to begin in the Dec 2021 - Feb 2022 period, and the Fed has more or less endorsed this timing. However, most expect rate rises to occur after the taper is completed in 2H22, whilst Chairman Powell left open the door for rate rises to be pushed out to 2023.
This dovish tilt, as minor as it might sound, resulted in the expected reaction in financial markets during the week but with conviction on Friday:
Global equities were higher across the board, with the Asian and emerging markets outperforming developed markets (see Table 1 following commentary)
US equity indices were also higher, with the value-oriented Russell 2000 bucking its recent trend and rising 5.1% W-o-W, whilst the more cyclical DJIA increased the least (1.0% W-o-W) (Table 2)
UST yields moved higher through mid-week, but then clawed back some of the increases on Friday following the economic symposium. As bond prices stabilised and moved higher, the yield curve also steepened, reflecting a more optimistic view on future US economic growth (Table 3)
In corporate credit, both yields and spreads were tighter W-o-W albeit modestly, with CCC spreads in particular recovering from a slow widening over the last month or so (Table 4)
Similar to UST yields, the US Dollar came off its mid-week highs and was lower into the end of the week, closing down 0.8% W-o-W. Gold was also higher as the week ended, up 1.8% W-o-W (close $1,820/oz) (Table 5)
WTI crude had its best week in several, shaking off downward pressures and increasing 11% W-o-W (close $68.67/bbl). Prices gapped up at the beginning of the week and gained further momentum on Friday (Table 5)
Bitcoin is hanging in the high $40,000 area, closing the week down 0.7% ($49,059), although as investors know, the intra-week volatility is severe (Table 5)
There is a UK bank holiday this Monday and the Labor Day holiday in the US the following Monday. I would expect this week to be reasonably quiet from the perspective of financial markets. Fortunately, we ended the week on a constructive tone, and financial markets largely remain in a “Goldilocks” scenario that continues to favour asset prices across the board. Risks on the horizon, which I mentioned last week, have largely been buried for the time being.
The tables below have more details on the weekly performance of financial assets this past week.
Table 1, Global Equities
Table 2, US Equities
Table 3, US Treasuries
Table 4, Corporate credit yields and spreads (BBB and high yield by rating category, USD and EUR HY)
Table 5, Safe haven and other assets, select FOREX rates