A Twist of FAIT

Jackson Hole

Fed Chairman Powell’s Jackson Hole speech was largely interpreted by the market as being dovish. Leading up to the speech, we were cautious about the prevailing consensus of a hawkish delivery. We felt the threat to global growth posed by the Delta variant would be the focal point of his message. However, Powell hardly mentioned Delta. Instead, he dedicated a significant chunk of his speech to articulating the case for inflation being transitory. Most importantly, he made a clear distinction between tapering and raising rates – stating that the threshold for meeting conditions for the latter is much higher than for the former. We believe that with this speech, Powell managed to put flexible average inflation targeting (FAIT) back into play after bringing it into question back in June. This means the Fed will allow inflation to run above its 2% target and will not react too quickly to any data that suggests the economy is running hot.
Our gold call played out well on Friday as the relationship between real yields and gold temporarily snapped back into place after having broken down over the last several weeks. Real yields (as indicated by TIPS) fell and gold rose. This could be partly explained by traders unwinding offside positions as sentiment leading up to the speech suggested the market was positioned for a hawkish delivery. The CFTC Commitment of Traders report, which is a snapshot of how traders are positioned (with a few days lag), was also released on Friday and confirmed that speculators were positioned for a risk-off move. Dollar buying was up substantially, Eurodollar shorts & fixed income selling increased slightly, and copper & oil holdings were down. This is hardly surprising given the hawkish signaling from Fed members in the weeks and days prior to Friday’s speech. Powell basically reminded us that the Fed leadership is still a lot more dovish than the regional reserve bank presidents.

Source: Nordea

Although tapering is still going ahead, the timeline for this looks to be November at the earliest. The Fed has told us they will give advance notice of a taper, making September the earliest date it can provide notice. By stressing a clear separation between tapering and a lift off in rates, Powell seems to be lowering the odds of a repeat of the taper tantrum we experienced a few years ago (which we would argue was partly the result of poor messaging by the Fed). All this essentially buys risk assets further time.


Given this backdrop, we think this paves the way for risk assets to do well in the rest of the year. The Rand has rebounded strongly and is still holding firm despite the weak local economic fundamentals.
We like the prospects for commodities in this environment, which bodes well for local resources stocks. We still maintain our bullish view on gold as a hedge against the inflationary pressures and excesses (as evidenced by the recent NFT craze) we see building in the system.


Of course, a key risk to this outlook is a potential slowdown in global growth going forward. Apart from the well documented risks around the emergence of Delta and future Covid variants, credit impulse is now negative in the US and peaked in China in Q2 of 2020.

Economic data coming out of China seems to confirm the slowdown, with recent non-manufacturing PMI numbers coming in significantly below expectations (47.5 actual vs 52.1 exp). Chinese authorities have indicated that they will implement stimulus measures this year to combat the slump. Commodities are likely to receive a temporary boost from this stimulus, and this could provide potential trade opportunities in the sector. However, another debt-fueled stimulus from Chinese authorities will be challenging to sustain. In addition to cutting steel output to curb emissions, China seems to be trying to reign in inflationary pressures. In July, Chinese PPI was running at 9% YoY, while CPI was running at just 1% YoY. It’s a delicate balance for authorities to manage.
But as always, when policy actions come into conflict with economic forces there will be opportunities waiting to be exploited from the market dislocations created.

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