Keep Alive That Questioning Spirit
The main event in August was Fed Chair Jerome Powell’s speech at the Jackson Hole Symposium. His message will resonate deeply with not just market participants but with anyone facing uncertainty in life.
August was marked by a mixture of calm and volatility, largely influenced by US Federal Reserve (Fed) Chair Jerome Powell's much-anticipated speech at the Jackson Hole Economic Symposium. Despite it being the peak of the summer vacation season, financial markets had their moments of turbulence, underscoring the challenges of navigating an uncertain economic environment.
Powell’s speech was the dominant event of the month, and his concluding remarks resonated deeply, not only with market participants but also with anyone facing uncertainty in their decision-making processes.
He stated, “The limits of our knowledge – so clearly evident during the pandemic – demand humility and a questioning spirit focused on learning lessons from the past and applying them flexibly to our current challenges.” This message is a powerful reminder of the importance of adaptability and continuous learning in the face of unprecedented economic conditions.
The unwinding of the yen carry trade at the start of August added to market volatility, and caused the VIX (a measure of stock options’ price changes) to experience one of its largest moves over a three-day period since March 2020. However, the panic was short-lived and the market rally soon resumed, raising questions about how much cash is on the sidelines ready to “buy the dip” or capitalize on any pricing dislocations.
In the bond market, the yield on 2-year US Treasury debt, which ended July at 4.25%, fell by 35 basis points to 3.90% by the end of August. This decline continues a trend that began at the end of June when 2-year yields peaked at 4.75%. Money markets have been experiencing a “lift-a-thon” (a lot of buying!) with buyers eager to lock in higher rates before the Federal Reserve begins cutting. The trajectory of these cuts will now heavily depend on labor market conditions. Powell commented, “We do not seek or welcome further cooling in labor market conditions,” highlighting the Fed’s delicate balancing act as it attempts to engineer a soft landing for the economy.
Despite concerns over potential cooling, the labor market remains robust. The unemployment rate, which bottomed at 3.4% in January 2023 – a level not seen since September 1968 to May 1969 – is far from its historical low of 2.5% in 1953 during the post-war economic boom. Nonfarm payrolls will be a critical indicator moving forward, providing further insights into the health of the labor market and guiding the Fed’s policy decisions.
Meanwhile, corporate credit yields have continued to trend lower, reflecting market expectations of a more aggressive path of policy easing. The 30-year mortgage rate also dropped below 7% for the first time since 2022, offering a glimmer of hope for prospective homebuyers.
In the overnight lending market, Secured Overnight Financing Rate (SOFR) volumes have continued to climb, now exceeding $2 trillion per day. However, SOFR yields are feeling some upward pressure as the Fed’s quantitative tightening (QT) program continues to drain liquidity from the system.
Despite this, bank reserves held at the Fed remain unchanged at $3.3 trillion, and the reverse repo (RRP) facility continues to drain over $300 billion from the system each day. There is speculation that the Fed’s quantitative tightening (QT) program could end this year, but it remains unclear why the Fed would taper QT when reserves have not decreased and the RRP is still active. With the Fed’s balance sheet still massive at $6.7 trillion, the highest in its history and about 25% of the gross domestic product, there are growing concerns about the long-term implications of such an expansive monetary policy stance.
As we move forward, the Fed’s actions and the labor market’s performance will be closely watched. There remains a substantial amount of money in the system, and the path to a soft landing remains uncertain. Markets will continue to monitor incoming data and Fed communications for clues on future policy direction.