Jupiter: Central bankers go fishing

August, when the world’s principal central bankers meet for their annual offsite at Jackson Hole, Wyoming. What a treat. Or is it more accurately a retreat? Retreating further into their own bubble, reinforcing their own prejudgements of the state of the global economy and the monetary policies to manage it? Or surely the ideal opportunity, particularly in the light of recent events, to take an ice-cold swim and a long hard look at their own performance, dispassionately investigating which policies worked, which failed and daring to challenge the status quo? Or is it merely an opportunity to swap war stories, patch their wounds and recuperate with a spot of sight-seeing and fishing (European Central Bank President Christine Lagarde attended a rodeo; how appropriate!) in highly agreeable surroundings before sallying forth into the economic fray again. It is a moot point.

While normally a talking shop, sometimes substantial policy changes are announced at Jackson Hole that catch markets by surprise. One such occasion was August 2020 when the Federal Reserve unexpectedly (as unexpected to its peers as the markets) announced it was moving the goal posts for the US inflation rate from 2% as a fixed monthly target and ceiling, to 2% as an average over a period of years. No longer a target; more an aspiration. Mischievously (or, with hindsight, stupidly) the Fed did not define the period. Allowing the inference of unfettered inflation (which we identified in a column at the time) this quickly became an elephant trap of the Fed’s own making: when inflationary forces were mounting two years ago but the Fed stuck rigidly to its narrative that the problem was merely transitory, there is absolutely no doubt Chairman Jerome Powell was assuming mean reversion in the inflation rate to the post-Global Financial Crisis trend of 2% or below; despite the hump, that would still allow him to be able to claim victory in achieving an average rate of 2% without having to change policy. So that went well.

 

The cornerstone speech at Jackson Hole is that of the head of the US Federal Reserve. Jay Powell spoke for 14 minutes. He said nothing new. His summary was that while US inflation has tumbled from 9.1% at its peak in May 2022 to 3.2% today, it remains “too high”. He reiterated his message from earlier in the summer that inflation must still be defeated, there is no cause for complacency. Almost burying his meaning in understatement, he vented his frustration that the US economy remains stubbornly buoyant (“the Fed is attentive to signs that the economy may not be cooling as expected”) despite the most aggressive interest rate tightening programme in the modern era. He wants below-trend growth for a prolonged period to be sure that inflation can be contained at the 2% average, even if it means increasing unemployment (the labour “rebalancing process is incomplete”: economist-speak for still too many employers seeking to fill too many vacancies for which there are insufficient numbers of available workers). In particular, his latest preoccupation is that as the rate of increase in nominal wages now exceeds the current headline rate of inflation and real inflation-adjusted wages are rising, that in turn might limit the ability to keep a firm lid on the medium-term inflation rate.

The issue here is the risk of masking: confusing what is merely the base effect in the fall in the inflation rate (the benefit of the combination of slowing prices and the comparative time series moving inexorably forward) and what among the components of inflation might have become more insidiously embedded. His message to the markets was that while interest rates have risen from zero to 5.5% in 16 months and inflation has fallen two-thirds from its peak, do not assume that future rate rises are ruled out, and do assume that interest rates will remain at elevated levels for longer than expected before they begin to fall. For what it is worth (bearing in mind many in the markets also have been persistently wrong in their expectations both of predicting the peak rate and the timing of rates receding again), bond investors are currently ‘pricing in’ a 7% probability of a quarter-point US interest rate rise in September with a greater probability of 43% in November.

The bigger picture, fallibility and an unexpected slab of humble pie

The overall theme of this year’s Jackson Hole symposium was “Structural Shifts in the Global Economy.” It reflected the need to address the geopolitical effects arising from three years of war and pandemic on global supply chains and their security, but also how consumers have changed behaviour. It attempted to focus on the immense prospective changes to economic systems arising out of the drive to carbon net-zero and the transition from a society based on three centuries of hydrocarbon and fossil fuels to one powered by alternative sources of energy in three decades; also, how labour markets might change in the face of rapid technological changes driven by artificial intelligence.

If Powell’s speech was addressed directly at the markets, the most perceptive in the context of the strategic brief was the ECB’s Christine Lagarde’s. She acknowledged that economists’ neat, tidy models can easily become dysfunctional and misleading when confronted with exogenous shocks to the supply and demand-sides of the economy. Pat conventional economic relationships can break down. In such circumstances the by-the-book policy response may be inappropriate. She carries the scars: Lagarde was the last of her ilk defending the ditch that the real enemy was deflation; it was only in July 2022, seven months after the Bank of England had stopped quantitative easing and begun raising interest rates, and four months later than the Fed, that the ECB was forced to capitulate and reverse direction away from its negative deposit rate and join the fight against runaway inflation in the eurozone. Thus, at Jackson Hole, her thesis was that central bankers as lead policymakers need to be much more adaptable in future; they need to be braver in changing tack before the full economic picture has become clear. Intriguingly for one not in the habit of being humble and seldom short of self-assurance, she declared: “the three key elements of robust policymaking are clarity, flexibility and humility.” (her own italics in the text of her speech). Perhaps the Mark Carney shibboleth of the supremacy of the central banker has been slain and lessons really have been learned since 2021 when inflationary pressures which were evident to investors were ignored or denied by central banks with consequences that were all too evident.

 

 

The fact remains that in an increasingly complex and highly dynamic period of economic, geopolitical and societal change, central bankers are not in control. They are not monetary sergeant majors, commanding inflation to advance, retire or turn left and right to order. Further, they have very few levers to pull; the two principal ones are interest rates and liquidity (quantitative easing or tightening, known as QE and QT, depending on whether the central bank is buying or selling its government’s bonds). It used to be the remit of central banks to control the money supply; arguably the multitude of routes by which money percolates into the modern economic system which now do not involve a central bank has not only eroded their influence but disintermediated that aspect of their role.

As the last three years have demonstrated, interest rates and QE/QT are virtually useless directly to control the supply-side of the economy. Changing the rate of interest or buying or selling a government bond does not physically unclog blocked-up supply chains; it does not prevent the Saudis and the Russians manipulating the oil supply to suit their own ends; nor does it magically produce lorry drivers from thin air as was the need in the UK in the autumn of 2021. Bank of England Governor Andrew Bailey (absent from Jackson Hole, he sent his deputy Charlie Bean instead but this week at the Treasury Select Committee Bailey insisted that inflation “will fall fast before the year-end” and that UK interest rates are “near their peak”) when looking at wage inflation regularly rails about shortages of labour supply with so many of working age being declared unfit for work; he knows that is entirely the responsibility of government, nothing he as Governor can do will alter the situation even though wage inflation is making his job doubly difficult to manage national prices.

On the other side of the equation, as alluded to in Powell’s speech, he and his fellow policymakers are also crossing their fingers that those available levers remain effective controls for the demand-side of the economy, curbing consumers’ behaviour in the endeavour to manage inflation. As we have noted before, interest rates and bond purchasing/disposal programmes are not precision instruments; they are blunt tools with inherent lags between implementation and a measurable effect. Time will tell soon enough whether what has been done to date is too much, too little, or about right.

 

Left hand, right hand and vice versa

Monetary policy is not an island. In a mature, homogenous economic system, to be successful, central bank monetary policy and government fiscal policy need to be coordinated. With the active collusion of the International Monetary Fund, across the western democracies with most governments being slaves to lazy centre-left Keynesian economic ideology and orthodoxy (active state intervention; subsidies and state aid on a prodigious scale particularly in the race to carbon net zero and infrastructure programmes; high debt levels and high tax rates), there is ample evidence of not only little if any coordination, but fiscal and monetary policy pulling in opposite directions.

We have observed on several occasions in these weekly musings that there is little in today’s economic conditions or policymakers’ responses to them that will be found in any conventional textbook of economic theory. This period will provide a curious case study for future students of economics and politics, prompting the question: “did that really happen? Why? How?”

No wonder asset prices are susceptible to periodic bouts of significant volatility! It pays for investors to keep an open and enquiring mind; nobody has all the answers. On the Jupiter Merlin team we have a guiding principle: when the facts change, we reserve the right to change our minds. A useful dictum!

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

 

 

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The value of active minds – independent thinking