Jackson Hole Will Signal Hawkish Tone for Financial Markets

The annual Jackson Hole economic symposium, a three-day conference in Wyoming begins on Aug. 21 with the official topic of “Re-evaluating Labor Market Dynamics.” Sure, there will be debates from the Bullard camp who views that there isn`t near as much labor slack in the economy versus  the Yellen camp who believes that the long-term unemployed will eventually come back to the economy once the job market tightens further. There will be interesting thoughts regarding the structural changes in the economy and how this effects full employment, and the mismatch between job requirements and candidate skillsets. There will be talk about wage inflation in the context of the largest addition of jobs since 1997 to the economy where even a bad employment number these days lands over the 200k a month level. 

But make no mistake the data this week finally has pushed the Fed`s hand, and they are going to have to raise rates by the first quarter of 2015. Even the employment bears, you know those Wall Street types who want more free money from their favorite central bank so they can continue this charade that is borrow everything you can and invest with anything that has a yield pulse, can no longer play the GDP and Inflation card. I know we are producing record jobs this year, but we had a negative 2.9% GDP in the first quarter and it was more than bad weather and an inventory overhang issue from robust 3^rd and 4^th quarters of 2013.

Well this week we finally put that argument to rest as the first look at second quarter GDP came in at a robust 4%, with the first quarter being revised up from a negative 2.9% to 2.1%, so the economy basically grew at a 2% rate for the first half of the year with one of the worst winters on record, and the working off of 2013 inventories. This bodes well since the US economy, being a highly consumer driven economy, really kicks into high gear the second half of the year. A lot of this is based upon the Fall Back to School Spending cycle, companies needing to spend budgeted money or lose it, Tax Spending, the Holiday Shopping Season, the ramp up of college and pro sports football season, and milder weather conditions in the bulk of the country. In short, 2014 will grow at a faster pace than 2013 when all is said and done!

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Employment Cost Index 0.7% 

The other interesting note this week in terms of data was on inflation where on Thursday The employment cost index (ECI) came out and showed a surge of 0.7 percent in the second quarter where pressure is evident in both the wages & salaries component, which jumped 0.6 percent in the quarter, and the benefits component which surged 1.0 percent. Furthermore, year-on-year rates all show significant acceleration and are near or above the general 2.0 percent policy threshold cited by the Federal Reserve. The total employment cost index is up 2.0 percent year-on-year vs 1.8 percent in the first quarter with wages & salaries at 1.8 percent, vs the first quarter’s 1.6 percent, and benefits at 2.5 percent vs 2.1 percent. 

So the CPI, PPI, and other inflation metrics in the various manufacturing and services reports are all signaling higher inflation it should be no surprise given a Fed Funds Rate between zero and 25 basis points since 2008, and now that the economy is actually producing jobs, and the labor market is tightening fast, that wage inflation is starting to perk up, and this is the next shoe to drop in the economic cycle.

The Fed is Behind the Curve

The Federal Reserve is already behind the curve, this is obvious as at no time in our history has the economy performed on this level with rates basically being held at ‘end of the world’ total meltdown levels! Sure Wall Street wants free money from Central Banks, this has been the easiest money making era of their lifetimes; now that rates will rise, they actually have to learn to differentiate between asset classes, companies, and investment strategies. This was what changed this week, these two important data points on GDP and Inflation put the nail in the ‘Free Money for Life’ coffin, and this sent shivers up the spine of financial markets! 

Market Turmoil 

The musical chairs game has already started in the high yield credit markets, the primary dealers are already signaling to the bond market that they don`t want to hold this paper, expect bond funds to finally get the message like the stampeding elephants that they are, and equity markets to start modeling valuations with a normalized borrowing cost for capital as interest rates rise early in 2015.

Hawkish Speech Outlining Turn in Monetary Policy

Look for a speech on Friday August 22^nd by Janet Yellen where she officially signals the end of the ‘recession era’ ultra-dovish monetary malaise of the last 7 years with a more hawkish tone to signal to financial markets that they better start finding their respective chairs before the low interest rate music stops playing entirely.