The Fed’s most dovish tone yet?

Interest Rates​

Last week, U.S. Federal Reserve (Fed) chairman Jerome Powell delivered a much-anticipated speech at the Jackson Hole Economic Symposium. In our view, it was a more dovish statement than the Fed had made previously, and a bullish one for markets. The first key takeaway was Powell’s comment that “the time has come for policy to adjust.”¹ This was the clearest indication yet that the Fed intends to transition to a rate-cutting cycle, and it bodes well not only for a decrease in September, but potentially multiple cuts thereafter. Secondly, Powell expressed confidence that inflation will get down to the Fed’s 2% target. However, he also highlighted that the U.S. labour market is cooling and that the Fed intends to do what they can to keep it strong. This tells us that the Fed believes it can manage a soft landing, and that in order to prevent any further downturn or slowing of the job market, it could move faster on rate cuts. Powell did state that the Fed would continue to be data-dependant with respect to the timing and magnitude of cuts, which gives them some room to maneuver in case one or two datapoints are offside. Markets had been pricing in some chance of a 50-basis-point cut in September, and this throws cold water on that notion. We’ve never believed that 50 bps was likely in September, so for us, this just confirms what we’d already suspected—a 25-bps cut next month is by far the most likely scenario.

Bottom Line: Powell’s comments were a good sign for the interest rate trajectory, and markets reacted positively to them.

Earnings

Both Target and Walmart have released earnings reports in recent weeks, and both companies beat expectations, causing their stocks to surge. However, it’s the consumer angle of these announcements—and Powell’s speech—that has our attention. Powell noted that the labour market has been cooling, but also highlighted that the rise in the unemployment rate over the past year hasn’t been caused by layoffs as much as it’s been the result of an increase in the size of the workforce and a slowdown in the pace of hiring. This further solidifies our view that consumers are still in relatively good shape and that they are continuing to spend, as we saw in both Walmart and Target’s earnings. That said, it’s important to understand that while Target is a higher-end retailer than Walmart, it is still toward the lower end of the spectrum. As such, their success is a strong signal that consumers are continuing to trade down. The same phenomenon can be observed from the other side: home retailers like Home Depot and Lowe’s had less positive earnings, which shows that many consumers are opting to defer their spending on big-ticket items and focus on staples. Even Pepsi and Disney highlighted that the lower-income consumer is feeling stretched. Some analysts had expected consumers to suddenly turn off the taps, but that’s not what’s happening. Instead, it’s been a gradual change as people’s excess savings have run out and they’ve started to shop around for better deals.

Bottom Line: While consumer spending patterns have shifted, neither Walmart nor Target observed that spending was slowing down significantly, which is positive news for the economy.

Gold

Gold is surging once again, with prices topping US$2,500 per ounce for the first time ever in mid-August and remaining near that level since². The precious metal remains one of the most significant overweights in our portfolios, and we’ve maintained that position for some time. We see three primary reasons for its strength. First is that gold is a popular way to hedge against softness in markets. While the current market has been strong, it can also be described as ‘a market with strong upside that people still feel nervous about.’ That’s led many investors to pursue a type of barbell strategy in which they stay invested but pair their equity exposure with a little protection in the form of gold.³ The second factor in gold’s strength is the unusual correlation between equities and bonds that we’ve seen over the past two years.⁴ Traditionally, investors would hold fixed income to offset their equity risk. But because of this high correlation, they’ve had to look elsewhere for diversification. For many investors, including everyday consumers, gold has been the asset of choice. Thirdly, central banks in some key countries are continuing to buy up gold in lieu of the U.S. dollar (USD). There are two possible reasons for that: hedging against potential rate cuts, which are likely to weaken the USD, or a desire be less reliant on the USD given the current geopolitical climate.

Bottom Line: Gold has already reached all-time highs, and we think it has room to move even higher.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Only fools rush in (or out): Caution calls for a rotation, not exit.