SUMMARY: Powell’s Jackson Hole communications will be consistent with the Fed’s hawkish goal to slow demand growth (and employment) to slow inflation, accepting recession risks associated with that. But as Gerard wrote this morning (HERE), don’t expect post-GFC-esque guidance on the rate path. The Fed has an incentive to be vague about the details of the instrument paths, but a lack of guidance does not imply dovishness. Some traders could take this as a reason to be long risk assets on the Jackson Hole event. And fintwitt could go nuts about a “pivot”. The only thing worse than actual inflation is Hypertakeflation and the sportification of macro (this is really good). Anyway, given how negative sentiment and positioning remains, we would not push back aggressively against that idea. Yesterday we noted that most of the market damage will likely be done INTO Jackson Hole, not on the speech. That view remains.
Longer term though, financial conditions look more likely to tighten as the Fed’s objective (the thing to focus on beyond this week and the hot takes) remains to slow economic growth. With demand growth remaining surprisingly strong, late-2023 fed rate hike expectations have increased. Fewer cuts are being priced. That will continue if payroll data is firm and CPI remains well above target. As investors internalize a higher for longer fed funds rate, financial conditions are likely to tighten. The bottom line, remain long factors, industries, and stocks correlated to tightening financial conditions (Low Vol and Defensives will benefit). We include top and bottom 5 stocks by correlation to financial conditions within each sector at the end of the report. In periods of financial conditions tightening this year, Energy stocks have done relatively well.
John Roque thinks the euro will continue to work lower to $0.85. Dollar strength will continue to be a headwind to stocks with high foreign sales. Tech and Health Care are the most exposed to higher foreign sales and Financials the least.
Full report below…
MARKET VIEWS: Powell’s Jackson Hole communications will be consistent with the Fed’s hawkish goal to slow demand growth (and employment) to slow inflation, accepting the recession risk associated with that. But as Gerard wrote this morning (HERE), don’t expect post-GFC-esque guidance on the rate path. The Fed has an incentive to be vague about the details of the instrument paths because guidance only introduces risk of reneging if it’s wrong, without providing the benefits it did near the zero lower bound. But a lack of guidance does not imply dovishness. Financial conditions will tighten again – remain long factors, industries, and stocks correlated to tightening financial conditions. We included top and bottom 5 stocks by correlation to financial conditions within each sector at the end of the report.
Powell does not have to push back against inflation expectations, which have moderated recently, in part thanks to lower commodity prices. That introduces some risk of disappointing expectations but, again, the Fed is committed to slowing inflation and its job is not done. That will be reflected in its actions, even if not in its immediate rhetoric. To be clear, we are not calling for a dovish surprise at Jackson Hole or pushing back against markets getting ahead of the Fed, merely pointing out some nuance into an event that is assumed to be hawkish.
Preliminary manufacturing PMIs missed expectations (the UK was particularly bad, dropping from 52 to 46). A composite of the preliminary reporters indicates an August contraction. The prices component is decelerating but remains in its 94th percentile. There has been improvement in supply chains and input costs alongside weaker activity.
USD STRENGTH: John Roque thinks the euro will continue to work lower to $0.85. Per John, “the US$ sharp year/year % advance is being driven, of course, by the weakness in the Euro. We’ve highlighted – or lowlighted – the Euro’s weakness for months in this form or in 22V’s Research Webinars with a downside target for the EURUSD of 0.85. Punk EURUSD action last week saw the cross come down and retest its mid-July low. It won’t be a surprise to see parity defended, but we continue to believe 1 will break and the EURUSD cross will get to 0.85.”
Dollar strength will continue to be a tailwind to stocks with high foreign sales.
Tech has the most exposure to high foreign sales. Health Care follows – the basket isn’t a pure risk-on vs risk-off play. Financials is the most negatively exposed.
FINANCIAL CONDITIONS: As promised, here are the top 5 stocks by sector benefitting from tightening financial conditions…
… and here are the top 5 stocks by sector at risk from tightening financial conditions.
