Updated: The annual Kansas City Fed Economic Symposium in Jackson Hole provided little in the way of the unexpected. The narrative provided by those speaking at the symposium did not focus on stimulus spending, monetary policy, or even the current state of the economy. Rather, Fed Chair Yellen and ECB’s Draghi both chose to give speeches that underscored two principle themes: the need to avoid rolling back financial regulations in a post financial crisis world, and a shared posture towards continued monetary policy accommodation in support of GDP expansion and overall domestic and global economic health. One additional theme that Mario Draghi focused on was the importance of free trade in an increasingly interconnected world. Importantly, Mr. Draghi did emphasize the central significance of fairness, safety and equity in his remarks on trade.
Observers of the symposium were clearly left with some unanswered questions. At the top of that list are the timeline for Federal Reserve balance sheet reduction, clarity on the ECB’s aspirations in regard to tapering, and any clue of how to harmonize a rising global interest rate landscape with balance sheet reduction.
The largest variable for investors, given the constructive economic data and earnings backdrop outlined in recent notes and above, is the anticipated Federal Reserve balance sheet reduction effort. In the FOMC Minutes released last week there was clearly a divided committee. Some members were pushing for a step into balance sheet reduction in July while others felt it more prudent to wait until the September meeting. Those members in favor of waiting until September won the argument. The argument being that a modest uptick in inflation before the September meeting is likely and that in that case it would make the sledding a bit less disruptive to credit markets.
Given the data outlined above, I think investors are likely expecting some followthrough on balance sheet reduction in September.
In any case, the balance sheet reduction that does likely commence in September will be modest and, at least initially, limited as to not disrupt markets. The cautious approach to reduction will to a large degree be informed by the backdrop of gradual monetary tightening. This week’s economic calendar is light. Jackson Hole will dominate and investors will be paying close attention to talks on Friday morning by Janet Yellen and Mario Draghi.