Warsh’s Jackson Hole Redemption

Lawrence Gillum (00:00):

Hello, and welcome to this week's edition of LPL Market Signals. I'm Lawrence Gillum, chief fixed income strategist on the LPL Research team, and I am your host this week. The interest rate environment has been a pretty volatile one ever since the new Fed chair, Kevin Warsh took over in May. And after two pretty, call it uninspiring press conferences, he was given a third opportunity at last Friday's Jackson Hole Symposium where he, for all intents and purposes, redeemed himself somewhat, at least in the eyes of the fixed income market. So to help unpack that recent symposium and provide some key takeaways and what that means for markets, I am joined by our chief economist, Dr. Jeffrey Roach. Welcome, Jeff, and thanks for the time today.

Jeff Roach (00:40):

Hey, well, good to be with you. And, maybe the mountain air helped clear some of the brainwaves. But, I think you're exactly right. There was, he did say, very similar themes, but maybe just in a better way and certainly made parts of the markets pretty happy.

Lawrence Gillum (01:00):

Yeah, for sure. And just to kind of get a quick overview of what exactly the Jackson Hole Symposium is, it's not really an FOMC meeting per se, but it is a pretty important meeting, for economists as it relates to kind of changes within the Federal Reserve body and other central bank, reaction functions, etcetera. And, to be honest with you, we've seen some pretty important, proclamations at some of these Jackson Hole Symposiums in the past. We had Ben Bernanke in his quantitative easing, speech. We had, Jerome Powell and his average inflation, targeting speech, a few years back. And to be honest with you, I was expecting more about the individual, you know, enhancements that they're going to make to the process here at the Federal Reserve, and not necessarily one that was centered around the inflation story, but we did get some of that, that discussion around the inflation story.

Lawrence Gillum (01:55):

So, I guess maybe to start, to kick us off, what Jackson Hole is, and, and then we'll get into the key takeaways.

Jeff Roach (02:03):

Yeah, that's right. So hosted by the, one of our district banks, we have 12 districts in the Federal Reserve system. Kansas City's one of them. They've been hosting for years and years since Volcker. And, you're right to highlight Bernanke, Powell, it's always an important event, because perhaps, you know, it's outside of Washington, it's outside of the day in and day out, daily grind. It's more of, philosophy, perhaps, explaining a new era of how they're going to manage policy. And so that's what I thought was helpful. One of the things, you know, I referenced at STAAC in our conversations, Lawrence, with the team at Research, we can learn a lot about what they're thinking as we say reading between the lines. In the, in this sense, it truly is, reading maybe not between the lines, but at the end of the lines, meaning, the chairman's speech is published on the Federal Reserve website, and the speech typically has important notes at the end, what kind of papers they reference, what kind of views.

Jeff Roach (03:17):

And I find it helpful to try to dig into what's going on behind the scenes by looking at, what they're referencing. Clearly, some of the papers that were highlighted in Warsh's speech were papers that were pretty negative on forward guidance. So absolutely no surprise there.

Lawrence Gillum (03:40):

So the forward guidance, or the lack thereof was, is really a contention with markets. I think not only did he, neglect to provide forward guidance, there was also issues about his reaction function or their reaction function, what was important to the Federal Reserve, as it relates to the inflation fight. He made it pretty clear though that the interest rate tool is their primary tool, and we did see an increase in rate hike expectations. But before we get into the market reaction, key takeaways, they are not done with the inflation fight. He made, it was pretty adamant about more work to do there. Kind of, what was your takeaway and, what should advisors and investors, think about his presentation?

Jeff Roach (04:25):

Yeah, that's right. So the inflation fight is not over. That's, you know, full stop. And I think that was important for, investors to hear. Warsh repeatedly emphasized underlying inflation pressures are too high. They have to get to that 2% target. Clearly, you know, dollar rallied on that news. I do think though, you know, that he was kind of upbeat in terms of the economic situation. We got strong capital spending, from AI build out, infrastructure build out. We have robust earnings growth. We have narrow credit spreads. All of these things are painting a fairly optimistic, and encouraging macro picture. So, I think that was helpful as well. One of the things he did call out, here and there, he did reference the task forces.

Jeff Roach (05:19):

One of the task forces is on communications. Another task force that I find, a lot more interesting because I think it has some, an opportunity to really improve things and make things better, but they have one of the five called the Data Improvement Task Force. It's co-headed by, a former CEO of Walmart. And, I think we're going to get some very practical takeaways from there. There was a brief reference. Obviously, it wasn't a focus of the meeting, or the speech, but a brief reference on that. So, it's very important to, as the pivot toward real-time indicators, that's an interesting call out, to me. And, again, an opportunity for, I think, policymakers to improve how and where they're getting their information.

Lawrence Gillum (06:14):

Yeah, so certainly more details to come from the task force. And, I do like the improvement in data collection. We've talked about this internally as well, that there's just a lot more ways to collect data versus just relying on a few, you know, survey releases and things of that sort. So, that would be a pretty good enhancement. But, I do want to ask about the inflation story. More work to do. He mentioned the breadth within these, indicators that are still too high. How are we thinking about inflation, and do we agree that we're going to be in this higher for longer inflationary environment?

Jeff Roach (06:53):

Well, I think in the near term, the answer is yes, inflation's going to be running above 3%, headline and core, way too hot for where, policymakers want. But I do think it's helpful to remember, if we have the patience to wait, I think by the time we get our October, November data and near the tail end of this year, we're going to see some improvements. Part of that's going to be a fading of tariff impacts. Part of it will be based on base effects because we had some really strong growth, infl - , sorry, pricing pressure in those months in 2025. So that's going to, make the calculations look, a little bit better. I think we're going to be, we're going to have a two handle, by the time we get to November. So that's certainly going to be, encouraging for investors. In the near term, though, it's still running too hot, and hence one of the reasons why there's a pretty strong probability of a Fed hike in September or October, those meetings.

Lawrence Gillum (07:59):

Well, let's talk about the probability of a rate hike in September. Going into the meeting, markets had priced around a 30% chance of a rate hike. After the meeting, we got above 50%. Surprised it didn't go a little bit higher than that given the, you know, the comments by Warsh. We're around 67%, chance of a rate hike in our, in the September 16 meeting. So hike or no hike? Put you on the spot here.

Jeff Roach (08:28):

It's a coin flip. Interestingly enough though, by the way, we're recording this, last day of the month of August. The last day of the month of July was the same situation. We just basically, after the speech, we moved back to the distribution of expectations that we had just a month ago. So, yes, there's been dramatic moves over the last two, three weeks. The reason why I actually started talking about this in our STAAC meetings a couple weeks ago, you have very strong consumer spending, strong capital spending, and very, very low unemployment, 4.1% unemployment. Does it mask, underlying stresses? It's hard to say because in addition to low unemployment, you have very low unemployment insurance claims, those that are filing for benefits. So you really, when you look at just the economic data, you would argue for, the need for a little bit tighter conditions.

Jeff Roach (09:37):

So, maybe a slightly, slight tilt toward hike. Although, and I, and I'll stop at this, LG, you can get back, jump back in. I say when you look at merely the economic data, you add pressures on how much the government is paying on interest, you have other geopolitical pressures, you have other, non-economic pressures. That I think explains, a real difficulty in trying to, guess which way it's going to go in September.

Lawrence Gillum (10:11):

Yeah, for sure. There was some interesting back and forth between the Federal Reserve and the Treasury Department a couple weeks ago, as it relates to Treasury Department, Scott Bessent obviously trying to keep yields from moving too high, too fast, with his buyback proposal. And then you had Warsh talk about the need to potentially hike rates, which would impact the debt servicing expenses at the Treasury there as well. So, it has been an interesting dynamic to watch those two, kind of competing interests in how they're playing out in the markets. As it relates to a rate hike though, if we go back to the last meeting, it was a split vote nine to three in terms of a pause. Does this, I guess, could we see a 7-5 vote in September either for a pause or for a hike?

Lawrence Gillum (11:03):

I guess, how divided is the committee?

Jeff Roach (11:06):

That's a great question. I do think we could see something like that because we know from the chairman that he likes, as he calls it, quote, "A good family fight around the conference table." Now, as we sit outside of the Fed as private sector practitioners, we'd say, "Well, that's great. There's no, there's less pressure of group think, and everyone is encouraged to come with their individual views." But what that does practically, it means that it's going to be harder to find consensus, and you could have several people dissenting for perhaps different reasons. We've seen that before as well. So short answer, yes. I wouldn't be surprised at all if we had more tighter votes.

Lawrence Gillum (11:57):

Yeah, and just something that we wrote about in our Midyear Outlook publication recently, you and I did, about just the lack of forward guidance, you know, the increased, dispersion within the committee, that probably means volatility within the rate, interest rate compound is, or complex is going to be a lot higher, and it has been, you just noted, effectively the round trip that we've seen in, out of the Fed fund, rate hike pricing. We've seen that out of the Treasury market as well. This is really the new normal, right? Without that forward guidance, without a general consensus amongst the committee, we're going to see a lot more interest rate volatility. Would you agree with that?

Jeff Roach (12:33):

Yeah, I do. I guess the one thing that would just maybe create a little bit of context is, and this is something that's, you know, thanks to financial news media, you know, this frustration about forward guidance. In some ways, we still are getting forward guidance, meaning, we know the tilt, on the chair. I think the district presidents will still talk their mind. We still, at this point, we still expect, throughout the years, a publication of summary of economic projections. Maybe the chair refrains from his dot on where that dot plot's going to be, but you still have some other, projections being made. So it's a little bit uncertain. We are getting some forward guidance. It's not as clear, and perhaps, because of that, you get a lot more volatility, and we certainly have seen this, as you just said, you know, a round trip on expectations where we were then to July, and here we are today, end of August.

Lawrence Gillum (13:42):

Yeah, I think, you know, one of the reasons why we didn't see a greater increase in rate hike expectations is because of that divergence amongst the committee. So, instead of one consensus view of forward guidance, you're, now you're possibly getting 12 different, you know, you know, 12 individual opinions about forward guidance where our rates are going to go. So that doesn't introduce a lot more volatility there. I do want to talk about job market is, jobs week here in the U.S. JOLTS, labor, market data. Kind of what are your expectations and would this meaningfully shift the rate hike conversation?

Jeff Roach (14:19):

Yeah, I think it could impact, if it were really outside of, you know, a two standard deviation move in that sense. So the previous month, we know that, jobs were suppressed because of local educational, payrolls. Private sector payrolls are still humming around that break even number of somewhere around 35,000 a month on average. The break evens basically is just a way of saying how much does the economy need to add to its payrolls in order to keep the unemployment rate stable? And we're in an environment where that break even is just a lot lower than it's been historically. And we're running around that 50- to 60,000, that's my expectations for next month, sorry, for August, which will be published, later this week, the first Friday of September. I do still expect a very low unemployment rate maybe by the end of the year.

Jeff Roach (15:25):

We'll see that uptick, a little bit. We have not seen much reason for an uptick, at this latest report. So I think it's probably going to come in strong enough, stable enough, in order to keep the hawks arguing for, a rate hike in, either in September or October.

Lawrence Gillum (15:47):

How are you thinking about wage inflation? Is that, problematic or is that still on a decent trend?

Jeff Roach (15:54):

Yeah, so that was one of the charts we showed in our Midyear Outlook webinar, unit labor costs have eased up considerably, and that is a good. It's a little choppy, but I think that's a good leading indicator for the wage side of the equation to not put any pressure on prices. I think in the near term, it's been tariffs, it's been uncertainty in the geopolitics. It's been about a strong demand for services, right? So we're seeing increases in, insurance, financial services, things of that nature. That's been supporting really hot inflation reads. I don't think we're going to have much upward pressure from wages.

Lawrence Gillum (16:41):

So, I guess going back to that rate hike conversation, if they do hike rates in September, is it one and done, or is this the beginning of a new rate hiking campaign?

Jeff Roach (16:52):

I think it'll be one and done. I think we're at this point, as we've seen in the last little bit, this steady state, certainly seeing growth in the economy, hot inflation, but perhaps a lot of the voting members were arguing for a wait and see because the inflation pressures were going to dissipate. So I think it's a chance that they hike once and say, "All right, we did the obligatory rate hike, but we're going to really be on hold because we want to see the balance of risks, become more neutralized." At this point, inflation is still the focus, and it's still not at the 2% target.

Lawrence Gillum (17:39):

Yeah, I will add, since this podcast is called Market Signals, market implied inflation expectations still look relatively range-bound, so no real concerns from the markets in terms of inflation becoming unanchored. And importantly, markets have really priced in a full rate hike by the end of this year and a 50% chance of a second rate hike this year. So markets have priced in a lot. So if the Fed does in fact hike rates either September, October, or December, that's already priced into markets, so we probably won't get a big reaction out of the fixed income markets, probably won't get a big reaction out of the equity markets or the currency markets. This is what markets are expecting, so if they become a little bit more aggressive than that, more hawkish than that, you could see a reaction.

Lawrence Gillum (18:24):

But, you know, I think markets are rightly pricing in the chance of a rate hike, and frankly, that's about it. So, I think we're in a good spot from a market perspective as well.

Jeff Roach (18:37):

Yeah, and just to harken back to the comments earlier on the dollar, so dollar rallied after the speech last Friday, that's certainly in line with the expectations that markets have that the Fed is going to keep its independence, its credibility in terms of this fight to inflation. Dollar certainly rallying again against a number of major currencies including the yen, as well as the Canadian dollar. So that is certainly supporting the market data that you just referenced.

Lawrence Gillum (19:14):

Yeah, and that goes back to the what we opened with and, a Fed chair that potentially redeemed himself in the eyes of markets.

Jeff Roach (19:24):

Yeah, I think it's interesting when you think what people were nervous about when the president nominated Kevin Warsh, there was a lot of concern, "Well, Warsh is just going to come in and be like Stephen Miran." Very different individual, and, certainly Warsh has seemed to find his footing and calmed, some of the fears, I think, at this point.

Lawrence Gillum (19:51):

I agree. All right, so we've talked Jackson Hole, inflation, jobs. Anything else that you're paying attention to this week before we wrap?

Jeff Roach (20:00):

Well, watching global markets, very important, the economies in Asia, Europe. So one of the things you referenced just on the outset of the podcast was Bessent's buyback program, the way that, the Treasury was intervening in those bond markets. That, of course, was followed by an earlier intervention by policymakers in Japan working in conjunction with the U.S. even though, the U.S. participation, the magnitude was pretty weak. But it's just important for our listeners to remember, when you try to intervene without fundamental changes, those interventions just don't last. So that's one of the things I'm looking at, just monitoring the fact that, you know, we still have some unusual pressures in Japan. Certainly a very weak yen was concerning. We've seen a yen intervention happen several times the last several years, and at this point, this most recent one, as of today here, end of August, the effects didn't last long, and the yen has again weakened, close to that 160 level that it tends to be a pretty important marker for policymakers.

Lawrence Gillum (21:19):

And it's a similar story out of the Treasury market. Even after that announcement by Bessent, we're seeing yields creep higher and back to the levels that they were before that announcement. So to your point, without a fundamental change in the reasons why yields are high and yen is cheap, things are going to kind of go back to where they were pre-announcement, and that's kind of what we're seeing now. So, with that, we can wrap. So thank you, Jeff, for the great insights as usual, and thanks to everyone for listening this week. We will be back again next week for another edition of LPL Market Signals. Take care, everybody.