We've Gone into an Inflationary Paradigm by Mistake

“We are indeed drifting into the arena of the unwell. Making an enemy of our own future. What we need is harmony, fresh air, stuff like that."

Jackson Hole and the Global Economy Shift

The highlight is undoubtedly Federal Reserve chair Powell speaking at 10.05 US Eastern time. The theme is "Structural Shifts in the Global Economy", so likely more about the long-term effects and goals for monetary policy rather than what’s going to happen next month. It will be all about deglobalisation and the long road/war ahead.  A change is coming. The BRICS are inviting new members to create a new axis of influence and perhaps (?) power...BofA notes in its Flow Show: “politics & policies of both G7 economies & BRICS-11 signal end of globalization…inflationary & hinder goals of net zero & peace.”

ECB’s Largarde Says,  ‘Engarde!’

In fact the shift has already taken place. I refer back to a speech by European Central Bank president Christine Lagarde earlier this year in which she – to me at least – gave a clear signal that we are about to go into a protracted economic (and maybe real) war and it will require the mobilisation of the state and people – developed world central banks (Fed, ECB, BoE, BoC, RBA) will act together to orchestrate fiscal spending and suppress yields. So, you can forget 2% inflation. She said the world is seeing “more instability as global supply elasticity wanes” and will see “more multipolarity as geopolitical tensions continue to mount”.  She noted how a period of “relative stability may now be giving way to one of lasting instability resulting in lower growth, higher costs and more uncertain trade partnerships”.

As I wrote in April:  “The expansion of the BRICS, the Chinese-brokered Saudi-Iran deal, Russian oil being washed in the East...it’s all pointing to division and an end of the Pax Americana. The death of the dollar has been talked about many times before and it’s never happened. I don’t think it’s much different today, but we are already seeing change.” As Lagarde noted, borrowing from Hemingway, “fragmentation can happen in two ways: gradually, and then suddenly”. 

Dollar hegemony was good for trade and for inflation. Lagarde notes: “For example, the ability of central banks to act as the ‘conductor of the international orchestra’ as noted by Keynes, or even firms being able to invoice in their domestic currencies, which made import prices more stable.” At the same time, Western payments infrastructure became dominant.  

Changing Dynamics of Trade, Currency, and Power

“But new trade patterns may have ramifications for payments and international currency reserves,” says the ECB president.

For instance, trade relations have undergone radical shifts in the last two decades. China has increased over 130-fold its bilateral trade in goods with emerging markets and developing economies. It is also now the world’s top exporter. Research shows, hardly surprisingly, significant correlation between a country’s trade with China and its holdings of renminbi as reserves. More yuan means fewer dollars, it being a zero-sum game.

“New trade patterns may also lead to new alliances,” warns Lagarde. “All this could create an opportunity for certain countries seeking to reduce their dependency on Western payment systems and currency frameworks – be that for reasons of political preference, financial dependencies, or because of the use of financial sanctions in the past decade.”

You can read the full tract here, but in short read more fragmentation on the global scene leading to multipolarity and the dollar being less dominant. None of which is conducive to lower, stable inflation.

Sanctions, Dollar Dominance, and Inflation Expectations

And recent events are only accelerating the trend. US economic sanctions on countries such as Russia could threaten the greenback's global dominance, according to US Treasury Secretary Janet Yellen  "There is a risk when we use financial sanctions that are linked to the role of the dollar that over time it could undermine the hegemony of the dollar," she told CNN. Every time the US deploys its ultimate financial weapon, it diminishes its power. 

A more fragmented world means inflation is not about to come back down to 2% easily. Unless you are Argentina or Zimbabwe you cannot keep hiking forever – central banks will in the end need to accept, or at least tolerate, higher inflation as the new normal. Whether mandates are adjusted may be a matter of taste. The effect will be the same..

And this is what Jackson Hole is all about today

Other Emerging Trends

BofA’s Flow Show also notes that tech's "Magnificent 7" stocks are up 93% vs US regional banks down 37% & China real estate bonds down 55% YTD...NVDA kept the party going but are we now seeing a top? They also note the “insane” in central bank liquidity over the last 15 years being the best correlation for tech...draining of excess liquidity likely to be a drain on tech stocks in H2 rather than AI leading the path higher.

Yesterday saw the rally burn out – megacap tech down over 2%, NVDA ending the day flat, AMD down 7%, sending the Nasdaq down almost 2% for the session and the S&P 500 1.35% lower to 4,376. The Dow had its worst day since March, sliding 1%, which may say as much about the lack of realised volatility we have had this year as much as anything else – the Fed’s firefighting efforts to ease conditions for banks has been a key factor but this is unwinding and with that you might expect some rotation out of the tech space.

Modest gains for European equities heading into the weekend but basically flat in the first hour of trade. The FTSE 100 is on course for a decent gain of more than 1% for the week, whilst the DAX is flat. Crude oil (WTI Oct) is firmer for a second day after finding support at $77.60, whilst gold has pulled back a touch in the face of a stronger dollar but remains bid above $1,900.

The dollar has indeed resumed its upwards momentum as expected, with DXY futures rallying to a new two-month high. No major move in Treasury yields with the 10yr still under 4.25%, but maybe some safety moves ahead of the Jackson Hole speech – higher for longer messaging expected. Also, Philadelphia Fed President Patrick Harker and Boston Fed President Susan Collins both welcomed the rise in bond yields, suggesting the move could help the Fed return inflation to target. It may also be down to the euro cracking at important technical that’s seen some stops run.

EURUSD – 200-day SMA breached

GBPUSD – momentum with bears after the 1.2610 support are went, now perhaps look for 200-day line at 1.240.