Hello my friends. Today is August 29th and this is Markets Weekly. All right, so last week was a pretty rangebound week in the major equity indexes. Nvidia of course had a phenomenal week. Now the big event last week was of course Jackson Hole, the big monetary policy conference where central bankers around the world go and fly over there, have a party and when the Fed chair historically delivers a very meaningful policy speech. Now, that speech of course in my reading was extremely extremely hawkish and all but promises a September hike. Now, to my surprise, there were actually many accounts on social media that didn't seem to grasp this and seem to think that it was just a nothing burger. So, today let's just break down what happened at Jackson Hole and understand its implications.

All right, before we begin, let's have some context. So the last time we heard from Warsh was at the last FOMC presser and at that presser Warsh basically despite sounding all hawkish didn't actually do anything. Couldn't explain why he wasn't doing anything and honestly just didn't really answer many questions all that well. What stood out to me then of course was that he suggested that the Fed would actually change the inflation index that they would target something other than PCE despite of course not hitting 2% PCE for a few years that of course was not very confidence inspiring and actually you could see Warsh basically beclouded himself and there were many many articles written about how that was just not a very good performance notably of course the long bond fund at that conference surged I think about 10 basis points again suggesting that the market was becoming a bit concerned about what the Fed was doing. Now between then and now it was very clear that Warsh took all that feedback into account and addressed it in his Jackson Hole speech. Now the ultimate arbitrator of whether or not a communication was hawkish or dovish is of course the market. And when you look at the market reaction to the speech, that really should tell you everything. Now, the 2-year of course is the part of the curve most sensitive to Fed policy and it surged 11 basis points that day. Of course, a very big move. And if you look at SOFR futures, Fed fund futures, they are now implying about two hikes in the coming year. So again, the market interpret the speech to be very hawkish. So it was hawkish. Full stop.

Now let's look into it to see why the market perceived it to be hawkish. Now taking into account of course the market's concerns heading into it, one of the big concerns that I pointed out and the market was worried is that the Fed, you know after failing its inflation target for such a long time, would just redefine the goalposts and you know just have a different inflation index. Warsh during his confirmation talked about things like trimmed PCE and then he talked about maybe his committees would unveil something that is different, but again he strongly committed in his speech that he would have 2% PCE as a fixed target. Again that was a good thing to do. That of course at least said the right things that the Fed was not just going to redefine its target in a way that would make sure it doesn't have to do [its job].

Now the second thing of course the market wanted to hear or at least was wondering is why isn't the Fed doing anything, right? He complains about inflation, inflation has been too high, but why isn't he doing anything? Now there is a few things in the speech that help address this. Now going back to his principle here, he talks about monetary policy as not self-executing. Now this addresses a critique, a concern that other people who have floated that is to say that you know you just can't get inflation down by just staring very very fiercely at inflation and hoping that it will cave. You actually have to do something, namely you have to toggle the policy rate, hike rates. And here Warsh is acknowledging that yes actually I just can't, you know, do nothing, it's not self-executing, I actually have to do something.

All right, now the second thing to highlight in the speech is how Warsh characterizes financial conditions. Now broadly speaking the Fed tries to influence economic activity by influencing financial conditions. When financial conditions are tighter that slows down economic activity and in theory should lead to lower inflation. So here in the speech, Warsh very clearly characterizes that financial conditions, you know, aren't really restrictive, right? So he points to the credit spreads. He points to loan growth and just straight out tells you that he doesn't actually think it's that restrictive. That is a huge billboard that tells you that, you know, he doesn't think that the Fed has done enough. If financial conditions are not restrictive, well, maybe you should do something about it. Now, remember, the Fed is a dual-mandate central bank. Full employment and price stability. In the piece, he very, very clearly says that there's nothing to worry about when it comes to full employment, unemployment rate at 4.1%. And, you know, maybe we just had this really good reshuffling of the labor market during the pandemic such that, you know, people are more matched to where they want to be. And so maybe that explains why we have kind of a low-churn market. So if the employment mandate is met, of course goes without saying that the inflation mandate is not met. So if you're really just worried about inflation and you think financial conditions are not really restrictive, obviously right, he's just telling you that yes, the Fed has to hike.

Now the third thing that I saw that I thought was a little bit new was how we characterize the Fed doesn't just have to get inflation to target, but also the speed of it matters as well. And that is to say that you know you just can't get inflation down to 2% one day far in the future and if you've been missing your target for say 65 months, that can't be characterized as getting to target in a timely fashion. And he also noted that as well. So again, inflation has been above target. Now, to be clear, it's lower than it was in 2022. The progress over the past 2 years has been modest and so he's introducing this additional speed element that's telling you that he's getting the sense of urgency that, you know, inflation has been above target for too long. So there are these three things that are honestly very very strong hints that rate hikes are coming.

Now, of course, Warsh doesn't like to give forward guidance. So, he couches this in a way as explaining how he's thinking about it and his principles. Doesn't promise upcoming rate hike, but they never even during the Powell days would just outright tell you that. Now, one other thing he does is he addresses possible objections to a rate hike. So one obvious objection is that hey you know inflation expectations are stable. There are some schools of thought that the Fed actually targets inflation expectations rather than actual inflation because traditional economic thinking is that if you have stable inflation expectations then inflation will gradually trend towards those expectations. Now he has a line actually expressly rebutting that, noting that inflation expectations are indeed very stable at the moment, well-behaved, but those can change very quickly. So it's not a reason for comfort.

So after looking at the totality of this you can see why the market very clearly priced in a much more hawkish path. However though for September it's still just 50/50. The market priced in a more aggressive hike path up to two hikes of course in the coming year, but for September it's still 50/50. Now my sense for this is because there is still a significant doubt as to whether or not Warsh will carry through. Is he just going to repeat of course what he did last time, a big game and do nothing? Is he of course, as many assumed once he was given the nomination, just Trump's pet and will do whatever the president says to try to get rates lower?

Now I think it's different because as we saw his performance at the last FOMC meeting was not good. He worked hard to address these faults in this speech. And of course the final fault that he has to address is he actually has to do something which of course he's already telling you. So in addition to that from a political standpoint we can see from last week that Bessent is worried about the long bond doing everything he can to try to make sure it doesn't go higher. Now one thing the Fed can do of course in addition to confirming that they're going to stay with PCE is of course to actually hike rates, show the market that they're doing something, maybe the long bond will calm down more. So, I think he does have the political support to do this rate hike. Might as well do it September. Don't do it October right before the November elections. Of course, it's also possible you can wait afterwards to do this in December. But, you know, after you've said so much, if you really don't follow through, you really are just a huge huge clown and no one will ever ever listen to what you say. So I do think that the odds of a September hike honestly I would say 90% rather than what the market implies. So that's one thing.

Now if there is so much doubt in the commentary and to some degree in the markets, again the short-term interest rate traders, the guys who trade rates, they understand this to be hawkish. My sense is that the guys who are in other asset classes maybe don't fully grasp this. The gold people do of course, you can see that gold did very poorly on Friday. Equity people not too much. So that suggests that we could have more repricing to go. To be clear there's a lot of mechanical factors happening right now. You can see the volatility is quite low and that kind of is grabbing things a bit. But I think though that there is potential as the market becomes more aware that this is indeed a real shift, that could upset further some of the risk assets.

Now that being said though, there is always a very dangerous thing that could for those who would like to sell the markets and that is the president holds in his hand this very powerful nuke that could send the markets go higher at any moment in time and that is he could declare some sort of understanding peace agreement with Iran that would of course cause oil prices to go lower, rates go lower and the stock market to go higher and he could do this anytime he wants. And so it's always kind of a hard thing just like the people who tried to buy oil realize that the president can kind of nuke you anytime he wants. Now if you do have that nuke though I think from the president's perspective when would you play it? Would it be right now or would it be later on?

Now the polls for the midterms are looking really really bad for the president. So it looks like, of course, the House is going to be lost. That's really not his fault. Historically speaking, when you have these midterm elections, you usually lose the House. But the Senate though, now it's a 50/50 toss up. And an extra wrinkle that happened last week of course was that we have increased confrontation with Canada. If you look at the Senate electoral map, you can see that some battleground states, Michigan, Maine, for example, trade a lot with Canada. And so that is of course further dampening the prospects for the GOP in the upcoming election. So I think that this does push towards some kind of political resolution with Canada, with Iran before the midterms, but honestly I don't know when, but when that happens it would be really risk positive.

So again, you got these two things happening. The prospect of more restrictive monetary policy and not being priced into the market, but also the event where the president can always nuke the shorts. So it's a very interesting setup right now. So next week of course is the final week before Labor Day and so I guess the last week of summer and afterwards we could I think expect some more volatility in the markets. So that's what I prepared for today. Thanks so much for tuning in. I'll talk to you guys next week.