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Before the Fall

by Karl Schamotta | August 26, 2016

Former Federal Reserve Chairman Alan Greenspan once told a Senate Committee, “Since becoming a central banker, I have learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said”. In just over an hour, the world will know whether Janet Yellen has mastered the same skill.

As a keynote speaker at the annual Economic Policy Symposium in Jackson Hole, Wyoming, the lady who speaks softly, but carries the world’s biggest stick is scheduled to deliver a scintillatingly titled talk on “The Federal Reserve’s Monetary Policy Toolkit”. By slowing down time for those attending, this sort of speech would normally be considered an excellent proof for Einstein’s theory of relativity – but with views on the Fed’s monetary tightening path increasingly polarized, traders and investors will listen extremely closely for any hint of directional guidance – and the stage has been set for an incredibly binary reaction in the currency markets.

After a series of relatively hawkish statements from regional Fed Presidents John Williams and Esther George along with Vice Chair Stanley Fischer earlier this week, further confirmation from Yellen would kick the big dollar into the stratosphere, while clobbering equities, commodities, and emerging market currencies. On the other hand, by suggesting that the economy has not yet reached escape velocity, Yellen could indicate that markets have mispriced the odds of a hike – and in so doing, trigger a rally in everything other than the dollar.

Our view is that Yellen will mumble – and that if she seems unduly clear to the markets, they will have misunderstood what she says.

With roughly a third of market participants already expecting the central bank to tighten policy in September and fully half expecting a move by December, financial market conditions have been tightening for months now. With the markets effectively performing the Fed’s work on its behalf, it is difficult to argue that there’s any need to clearly telegraph the central bank’s intentions at this point. As such, we’ll be inclined to fade any major move in the talk’s aftermath.

With investors increasingly convinced that Yellen is about to stop refilling the monetary punchbowl, some of the unrulier guests in the financial markets are drifting out the door, putting pressure on key raw commodity benchmarks – and on currencies like the Canadian dollar. The loonie remains firmly rangebound today, hesitating to push higher ahead of what will likely be a disappointing oil producer meeting at the end of September, while also supported by a relatively firm crude oil price.

With the August non-farm payrolls number due to land on Friday and most developed-economy market participants returning to their desks over the next week, conditions are ripe for a shift in trading narratives. After a summer characterized by depressed rates, low volatility, robust cross-asset correlations, and strong demand for high-yielding investments, it is reasonable to assume that veteran traders will begin to trim exposures and rebalance portfolios in a more discerning manner. For corporates, defining risk tolerances and placing stop losses in the coming days would be a worthwhile exercise – while the current sense of optimism could certainly carry us well into the autumn, as some wise folks once observed, “pride goeth before destruction, and a haughty spirit before a fall”.

Have a great weekend, and stay cool.

Karl “Chicken Little” Schamotta

Head, Enterprise Risk

Follow @vsualst


Reading suggestions to accompany your Saturday morning crepes:

Reuters: Britain Escapes Brexit Bomb, For Now

Council for Foreign Relations: China’s Ever More Mysterious Tourism Numbers

Macro Man: Lowest Vol in Lifetime

McKinsey: How Much Control Does the Central Government Really Have in China?

Bloomberg: China’s Debt Problem Isn’t Quite What It Seems

The Economist: Improve Your Life by Tossing Coins

Bloomberg: Are Index Funds Communist?

BBC: Ramen Noodles Become Currency

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