Jackson Hole – The time has come
Last week, Fed Chair Jerome Powell came with a rather dovish message at the global central banking conference at Jackson Hole. The central banker guided explicitly for a cut in September, but added that size and depth of cuts depend on labour market weakness. The tone on the economy was overall worried, and Powell pointed out the Fed has ample policy space to respond to any unwarranted weakness. The message was not a big dovish surprise for the rates market, as the US curve prices 200bp in cuts over the next year and a half. However, the “Fed put” feels stronger than anticipated, with the central bank clearly ready to step up cuts in case data worsen even in the very short term. The Fed will start the cycle with a 25bp cut on September 18. The next key set of data is August payrolls, to be released on September 6th.
Markets – August volatility faded (for now)
Markets have normalized back quickly, after a volatile beginning of the month. The VIX index (a measure of constant, 30-day expected volatility of the U.S. stock market) is now back at 15, the one-year average, after having spiked to 65 on August 5th. Equity indexes have rebounded too, and S&P is back close to highs. The stabilization was driven by a more pragmatic Bank of Japan, which stated the pace of tightening will take into account markets, and by the fact that US data are not deteriorating as quick as markets feared in July. Rates market remain more bearishly priced, with chances of 50bp cuts still baked in the curve and a “recessionary” cutting cycle priced for the next year. Ultra long bonds in US are now trading above the front end, for the first time in the past two years. Historically, this has been a bearish sign. We stay cautious about back to school: data are deteriorating faster than priced in credit spreads and equity valuations, and volatility is back subdued ahead of key event risks such as US Presidential elections. Fed cuts will be deeper than market expects only in a scenario which is negative for risks, limiting the ability of central banks to support risk shorter term.
Algebris Investments’ Global Credit Team
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