The Dog Days of Summer

by | August 16, 2021

Mid-August is often referred to as the ‘dog days’ of summer. The saying arises from the observation, first recorded in ancient Greece, of the arrival of Sirius—the brightest star in the constellation Canis Major (‘big dog’)—into proximity with our sun. According to the ancients, that interstellar convergence was the source of summer’s scorching heat.

Today, however, the dog days evoke images of panting hounds seeking respite beneath the porch. For investors, the dog days are a time of lazy relief from the white heat of markets.

The coming week may epitomize the popular yore of the dog days, when not much happens apart from the occasional siesta in the shade. Languid markets are on tap as a solid second quarter corporate earnings season pleasantly winds down, and as few important data releases crowd the upcoming calendar. 

But lazy market conditions may not last long. The end of summer approaches. The most treacherous market months of September and October lie ahead. 

Also, in ten days the Federal Reserve Bank of Kansas City will host the Fed’s annual gathering at Jackson Hole, Wyoming. In the shadows of the Tetons, central bankers, economists, and journalists will gather to discuss a variety of topics under the heading of ‘Macroeconomic Policy in an Uneven Economy’. 

When the symposium planners first proposed the conference title, ‘uneven’ probably had different connotations than it does today. Discussions of income or public health inequality were probably envisaged. Sorely needed infrastructure improvements might have made the agenda. Or perhaps seminars devoted to environmental degradation, budget deficits or crumbling free trade were on tap. 

Events have a way of intruding on agendas. Today, the most important policy debate is between monetary ‘hawks’, who believe the Federal Reserve (and other central banks) must soon rein in their expansionary policies, and ‘doves’ who believe aggressive monetary easing remains necessary to restore full employment.

In short, the question that will dominate at Jackson Hole reads: When should central bankers slow (‘taper’) asset purchases? 

The answer is hardly straightforward. But history suggests that getting it right matters for markets. For instance, in May 2013 oblique references by then Fed Chairman Bernanke to tapering sent the bond market into its infamous tantrum.

Still, several aspects of any monetary policy shift are clear. First, proper communication ought to precede concrete policy steps. Second, the aim—if possible—ought to be gradual, not abrupt, policy change.

Sudden shifts are best avoided, primarily to minimize the risk that financial markets might seize up. Of course, there are no guarantees. Even subtle hints can lead to market ructions, as Bernanke and the Fed discovered to their chagrin in 2013.

Gradualism dictates that the first policy step ought to be a slowing of asset purchases (‘tapering’), rather than a sudden stop. Only after asset purchases have concluded does it make sense to shrink the central bank balance sheet. Even then, it is preferable to first allow maturing assets to roll off the balance sheet before engaging in direct sales of notes and bonds. Hiking short term interest rates is best left to an even later date.

Indeed, that was the playbook from 2017-2020, when the Fed ended ‘quantitative easing’, a measure it had adopted during the financial crisis, and sought to ‘normalize’ policy.

But gradualism is only possible if the macroeconomic backdrop remains benign. Both inflation and recession must be avoided if policy shifts can take place smoothly over time. 

Today, with inflation surging above the Fed’s target, overheating presents the greatest risk to gradual policy adjustment. If the Fed delays too long, it may have to respond swiftly to avoid a sustained inflation overshoot—with the risk that an abrupt policy shift could wreak havoc on markets.

Investors also know that the Fed must act with incomplete information. Leads and lags between employment, labor market slack, wages, prices, and productive capacity are always uncertain, but arguably they are even more so today given pandemic-related dislocations to the economy. Metaphorically, the Fed will be attempting a glide path landing in foggy conditions without the benefit of precise instruments to guide it safely to the runway.

The margin for error in markets is small. Bond yields are absurdly low, highlighted by real (inflation-adjusted) long-term interest rates at minus 1.25%, far below any plausible level of ‘equilibrium’. Equity markets are almost as overvalued, in part courtesy of low bond yields. If the Fed acts too late and thereby stokes fears of inflation, bond prices will slump, interest rates will soar, and equity markets will crash. But if the Fed moves too soon or too quickly, it could precipitate recession, a collapse of corporate profits, and a stock market swoon.

It is little wonder, therefore, that market participants will be fixated on what Jerome Powell and other Fed officials say at Jackson Hole, as well as on subsequent Fed statements, speeches, and testimony over the remainder of 2021. 

The dog days of summer have arrived. Best to grab a cool drink, find shade and get some rest, while that is still possible. But keep an eye out for Canis Major—the big dog, aka the Fed. That canine is moving into a celestial position where more than just the outside temperature might heat up.

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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