Jackson Hole Dark Side Stab

Today is the day. Both Draghi and Yellen speak later at Jackson Hole. Although expectations for market moving news have been damped down, the market might be getting a little too complacent.

Over the past month or so, bond markets have been drifting higher on the assumption the Fed would take a dovish wait-and-see approach to the introduction of quantitative tightening (widely expected to be started in September.) On the other side of the Atlantic, investors are increasingly pricing in a slower tapering to the ECB’s quantitative easing program, believing Draghi would rather overshoot than risk pulling a Trichet by tightening and then be forced to quickly resume easing.

Have a look at the movement over the past three months of the Fed Funds futures’ curve:

The Fed Fund futures curve has not only shifted downward (in terms of yield), but also flattened with the far month contracts falling farther than the near months. This means that not only is the market believing the Fed will tighten more slowly, but that the number of raises is also declining.

As for the European markets, there are no expectations of changes to the front end of the curve, so we need to look at the longer end to get a feel for what is occurring.

After breaking out earlier in the summer, German 10-year bund yields have given up 25 basis points and have slipped back into the range.

The longer end of the curve does not move solely on short term rate expectation changes, but the moves in both German and US 10 year yields seem to indicate traders are expecting a dovish Fed and ECB. If there was to be a surprise at today’s Jackson Hole symposium, I doubt it would be that either Draghi or Yellen tries to get out ahead of this dovishness by signaling even easier policy.

No, a surprise will most likely look like a Central Bank chief that attempts to put policy back on the previous tighter path.

Most likely they will both duck and try to not disrupt the markets. But there is a better chance than the market is anticipating that one of them (or maybe both of them) surprises with a hawkish statement.