Reading the Runes at Jackson Hole

The legions of financial journalists that descend on Jackson Hole in the US state of Wyoming each year, do so for one reason. They are there to decipher the cryptic utterings of the world’s central bankers in the hopes of giving investors and financial markets something to act on.

So while Jerome Powell, who chairs the US Federal Reserve, was not the only reason for investors to pay attention to what goes on under the gaze of the magnificent Teton mountains, he’s a good place to start.

But while the focus at the Jackson Hole meeting rightly centres on the policymakers, it is actually a forum for sharing ideas and presenting papers.

This year’s theme was “Structural Shifts in the Global Economy”, and there were papers a-plenty on how things are changing under the opaque clouds of geopolitical and economic uncertainty. 

Cloudy Skies

Powell did not disappoint the rune-watchers at this year’s meeting, which ended last Saturday. He was quite blunt in saying that official US interest rates were likely to rise further.

But other than that, he got very cryptic about the need to be cautious in a world of seismic geopolitical, technological, and demographic change.

“We are navigating by the stars under cloudy skies,” he said, which may be a bit worrying for those relying on the Fed ship to avoid the rocks on behalf of the global economy.

The mixed message had the usual mixed results.

One was that short-term US yields rose (because people sold in anticipation of higher rates) more than did long-term yields (because people reckoned the era of higher rates is playing out).

The yield curve itself remains “inverted” with shorter-term yields higher than longer ones (translation: you get less return from investing over 10 years than you do over two).

This typically is a harbinger of recession. But Powell said the world-leading US economy was strong, so investors will have to make what they will from the this-versus-that report card.

Philosophical Lagarde

European Central Bank President Christine Lagarde, meanwhile, was in splendidly metaphysical form. Referencing Danish philosopher Søren Kierkegaard, she said: “Life can only be understood backwards; but it must be lived forwards”.

Her context was that the extraordinarily unusual times we are living through mean that we all, central bankers included, cannot simply assume that what went before will dictate what should or will happen now.

Lagarde rang out some of the changes: geopolitical threats, rising energy costs, shifting trade patterns, climate change, automation, transitioning to renewables, and fragile supply chains.

In the short term, she implied, European rates will go up because of inflationary pressures. Central banks, meanwhile, need to practice “clarity, flexibility, and humility” in steering the world through its troubles.

Worryingly, however, she had a message that was not dissimilar to Powell’s navigating under clouds: “We will only ever truly understand the effects of our decisions after the fact”.

That’s certainly humble, but not altogether reassuring.

Finding Ideas

Stanford University Professor Charles Jones described one of the headwinds facing the global economy as the increasingly hard task of finding “ideas”.

There were tailwinds, of course, such as the likelihood of a future Steve Jobs being out there ready to unleash some potential.

Harvard Professor Laura Alfaro, meanwhile, highlighted a “Great Reallocation” under way in global supply chains. Essentially, the United States is trying to kick its China-sourcing habit and looking elsewhere to places such as Vietnam and Mexico. The jury is out on how well this will work.

For investors, however, the most pertinent paper probably came from Stanford University Professor Darrell Duffie, who looked at what happens when some big event à la COVID or Ukraine comes along.

Dash for Cash

Duffie reckons that the balance sheets of bond dealers are not up to snuff – neither large enough nor flexible enough - to deal with what he terms the “dash for cash” that comes with an unanticipated global crisis.

“Since 2007, the total size of primary dealer balance sheets per dollar of Treasuries outstanding has shrunk by a factor of nearly four,” he notes. 

This could mean that come the next global crisis, investors may struggle to liquidate, or cash in, their positions. Indeed, back in March 2020 when the World Health Organization declared COVID-19 was a global pandemic, this was just the case, requiring central banks to step in as backstops.

Duffie makes a series of suggestions for fixing this – but until some action is taken, the risk to investors remains.