Jackson Hole Speech - Stocks Gear Up

Slight Selloff As Market Awaits Jackson Hole Speech

It seems like all the market cares about is Fed policy because it barely moved on Thursday even though there was a lot of economic data released, some of which I reviewed in a previous article. As I’ve discussed in previous articles, Powell is speaking at Jackson Hole on Friday. That’s probably why stocks barely moved. The S&P 500 fell 5 basis points, the Nasdaq fell 0.36%, and the Russell 2000 fell 0.25%. The VIX was up 0.88 to 16.88 which is still low. The CNN fear and greed index stayed at 25 which is extreme fear. Finally, every sector didn’t move in the same direction. The action was mixed.

Healthcare Stocks Fall As Left Presidential Candidates Poll Well

The best 3 sectors were the financials, real estate, and consumer staples, which increased 0.62%, 0.43%, and 0.43%. The financials like the recent selloff in treasuries. The 2 worst sectors were materials and healthcare which fell 0.7% and 0.49%. The latest Democratic primary poll was great for the left wing which has been bad for healthcare stocks in the recent past.

In the Economist poll, Biden was at 22%, Sanders was at 19%, and Warren was at 18%. Biden still averages a 12.8% lead. Candidates are starting to drop out which will change the dynamics of the race. There are 10 candidates that have qualified for the September 12th debate. Tom Steyer and Tulsi Gabbard are 1 and 2 polls away from making it, which would split the debate into 2 days, slowing the winnowing process. Regardless, we are still headed to a point in a couple months where this becomes a 3 candidate race.

Powell Speech To Impact Markets

Normally, the Jackson Hole speech has more to do with policy in the next year, but there is a great deal of uncertainty about policy for the rest of this year, so Powell can’t ignore that. There has been a major shift in policy expectations in the past week partially because of the hawkish Minutes. Last week, there was a 31.5% chance of a 50 basis point cut in September and a 100% chance of at least one cut. Now there is an 88.8% chance of at least one cut.

Essentially, that’s a shift of 43.7%. Technically, that might not matter to policy because in both cases the Fed was likely to cut once. However, it has affected markets, causing the yield curve to invert. The latest difference between the 10 and 2 year yield is 1 basis point as the 10 year yield is 1.64% and the 2 year yield is 1.63%. The latest 10 year German bund yield is -0.64%. That’s actually higher than where it was recently. It bottomed at -0.712% on August 15th.

Similar to the expectations for September policy, the expectations for December have shifted sharply. On August 16th, there was a 60.6% chance of at least 3 more cuts this year. Now there is only a 26.2% chance of that. By far, the most likely choice is 2 more cuts as there is a 47.4% chance of that. The Fed will cut in September and then in October or December. Three total rate cuts this year is still not a mid-cycle adjustment in my opinion. It’s good to see traders not panicking at this change. However, the real challenge will be how the economy does in the next few months. Scarily, that might hinge on trade policy which is uncertain.

Big Negative BLS Revision

The March 2019 employment revision was dramatically negative as the number of jobs created from early 2018 to early 2019 was revised lower by 501,000. That makes the boost related to the tax cuts look much smaller. The chart below shows the change to the employment growth rate because of the revision. Job growth from the start of 2018 fell from 1.5% per year to 1.3%. The negative revision was the worst since 2009. The largest negative revision was to the number of jobs created in leisure and hospitality which fell 175,000. It’s not surprising job growth is low because the labor market is nearly full. This supports not getting too excited by the month to month BLS reports because they can be revised sharply. This period’s final revision will occur in January 2020.

Weak Kansas City Fed Manufacturing Report

Similar to the Markit PMI, the Kansas City Fed manufacturing index fell. It went from -1 to -6. I’m fairly confident the ISM manufacturing PMI will fall modestly when it’s released on September 3rd. The Kansas City production index increased 4 points to -2. However, the shipments and new orders indexes fell 7 and 14 points to -7 and -16. In the expectations category, the composite was up 2 points to 11. The shipments index was up 3 points to 20 and the new orders index was down 6 points to 11. The capex index was down 2 points to 12.

In the selected comments section, 5 of the 11 firms quotes mentioned tariffs. One firm stated, “Sales are starting to decline across all of our major retail accounts. I am having a hard time explaining to major corporations that China is paying for the tariffs at the same time I am request a price adjustment due to tariffs.” Without the tariffs, the manufacturing sector would probably be doing solidly and outperforming the rest of the world by even more.

Conclusion

The stock market will react sharply to whatever Powell states in his Jackson Hole speech on Friday at 10:00 AM. It’s good to see stocks not plummeting at the suggestion that the Fed will only cut rates 2 more times this year. The BLS employment revision was terrible. The post-tax cuts bump wasn’t that large. The Kansas City Fed manufacturing index showed the manufacturing sector weakened in August. That’s different from the Empire Fed reading, but similar to the Markit flash PMI. I expect the ISM manufacturing PMI to fall modestly in August. 

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