Upbeat macro thoughts as Fed’s Jackson Hole Symposium begins

I haven’t posted much recently – mostly because there haven’t been many developments economically that change my macro view. We still live in a slow growth world, where recession is not the base case n the US, the UK, or the eurozone. And none of the data we have seen in the last few weeks has changed that path.

If there is any change to my view, however, it is toward more optimism. When I look at the data coming out of the US on GDP growth, jobless claims, retail sales, non-farm payrolls, or what have you, all of it says the economic recovery will continue for the foreseeable future. None of it points to imminent recession. And in fact, if you look at the recent housing data, it points more to a mid-cycle pause than the end of cycle dynamics I tend to believe are at work.

The US is working through an investment slump due to the shale oil misallocation of resources that is unwinding due to the fall in oil prices. The question, as we work through this period, has always been whether the economy is slow enough, and the negative impact of oil sector investment big enough to induce an economy-wide contraction. And the jury is still out on that question. To the degree the US can find a new engine of growth – like residential investment – the economy can continue forward.

As the Fed meets at Jackson Hole, this is the backdrop to their policy choices. The Fed is telling us that it believes the economy is indeed robust enough to power forward, so much so that it can slowly normalize interest rates. And while 25 basis points here or there won’t matter to the path of the economy, the signal the Fed sends about the potential for monetary policy divergence is the biggest marker to look for during the Jackson Hole Symposium.

When I ended my last note here at Credit Writedowns, I wrote that the big new risk re-emerging in the global economy and financial markets is policy divergence. I believe that because of Brexit, it is as a great a risk now as it has been at any time in 2016. Brexit has forced the Bank of England into easing mode and kept the ECB there as well. Moreover, it has forced the Japanese Yen higher, keeping the Japanese in easing mode as well. Every major central bank, including Canada, Australia and New Zealand are now in easing mode. The only exception is the United States.

The combination of policy divergence and zero or negative rates means greater risk for carry trades unwinding with heavy losses, whether because of currency effects or a sudden return to risk-off sentiment somewhere in the investment universe. To me, this macro environment still favors the convergence to zero trade, particularly regarding overweights in government bonds in New Zealand and Australia, and to a lesser degree, Canada. Brexit has squeezed as much as we are going to see out of the British convergence trade without a negative economic shock. And my optimism about the US economy makes a US Treasury overweight less compelling.

So, it’s steady as she goes on the slow growth global economy. Let’s see what Janet Yellen and the gang have to say about what the Fed is going to do and re-visit assumptions afterward.