RiskBridge made its annual trek to the Teton Economic Outlook in Jackson Hole, Wyoming, where market participants and the intellectually curious gather to kick the tires of the economy, monetary policy, elections, and markets. We’ve attended this perennial event organized by the Global Interdependence Center for nearly a decade.

The GIC is an important organization dedicated to bringing together a global network of experts and members in neutral, nonpartisan forums to explore globally interdependent issues and policy themes impacting world economies and living standards.

The Jackson Hole event gathers economists, policymakers, allocators, fund managers, entrepreneurs, business owners, and media. It is a truly unique forum where Wall Street meets Main Street.

What were we hoping to take away from this year’s event?

First, we wanted to validate RiskBridge’s base case that the economy is heading for a soft patch. Most speakers shared this view, supported by the first downgrade in a year to the U.S. real GDP forecast, which fell to 2.3% from 2.4% according to the Bloomberg consensus survey of economists. We consider economic growth above 2% as generally favorable, but the level of growth matters less than its rate of change.

The consensus among conference attendees was that it is unlikely that the U.S. will slip into a recession in the next twelve months.

Second, getting the inflation call right is critical to portfolio construction and future investment return opportunities. RiskBridge’s base case is for inflation to remain elevated and sticky, with headline CPI staying around June’s 3.0% level. One speaker made the case that a second wave of inflation can’t be ruled out based on historical evidence. The Chief Economist of the Conference Board discussed a nationwide survey of CEOs from the largest U.S. companies and found that 57% plan to hike wages by 3-4% in the coming year.

The morning keynote speaker, a former Federal Reserve Bank president, argued that inflation is not yet under control and that, if he were still a voting member of the FOMC, he would not support a rate cut. This supports RiskBridge’s view of “inflation higher-for-longer,” but the band of uncertainty is wide. 

We note that allocators and speculators are betting that the Fed will cut rates at the September 18 FOMC meeting, with a 96% probability implied by futures pricing (Source: Bloomberg). We are not so sure. It is important to respect what the market is telling us, but with everyone standing on the same side of the boat, one can imagine the disruption if the Fed fails to deliver a cut in September. 

Third, our favorite technical analyst highlighted that abnormally low volatility across the volatility complex (equities, rates, credit, FX) is subject to a trend reversal where volatility rises, and investors experience larger price swings across asset classes. A catalyst for higher volatility could be corporate profit disappointments. Wall Street analysts expect S&P 500 operating profit margins to rise to 14% in 2025 from 12% in 2Q24 (Source: Factset). We believe this is too aggressive in the context of a downturn or stagflation regime.
 
A fourth theme that appeared throughout the conference was “Where are the bond vigilantes?” As a reminder, a bond vigilante is an investor who threatens to sell bonds to express disapproval of certain policies undertaken by a government, in this case, the U.S. Treasury. Bond vigilantes roamed global bond markets from the 1970s to the 2000s, dispensing justice to spendthrift governments by selling sovereign debt, pushing bond yields higher, and raising the government’s borrowing costs. In the era of quantitative easing and reverse repos, there are no bond vigilantes because the Federal Reserve dominates bond yields and the price of money.  

During an era of globalization, the marginal buyers of U.S. Treasury debt were foreign central banks and trading partners. As the world continues to de-globalize, the new marginal buyers of Treasury bonds are insurance companies and pension funds, which are typically much more active traders than foreign governments. As these new buyers take a greater share of outstanding Treasury issuance, perhaps the path is being paved for the next generation of bond vigilantes.

During a morning panel, David Kotok, CIO of Cumberland Advisors (and RiskBridge Advisory Board member), delivered an in-depth study that estimates the financial cost of U.S. fiscal and political irresponsibility; a combination of a federal budget deficit of 5.5% of GDP, the U.S. debt ceiling continuously kicked down the road, and political uncertainty. Kotok analyzes the liquid, tradeable “insurance” instruments at different points across the yield curve to estimate that the U.S. pays an extra $27 billion per year in interest costs through a higher interest rate premium due to our country’s inability to get its fiscal house in order. We consider this an “irresponsibility premium,” like those embedded in some emerging market bonds. David has granted permission to share his presentation slides.  

Finally, nearly 40% of the world’s population will participate in some form of national election this year, providing plenty for conference attendees to discuss and debate. According to Predictit, Joe Biden’s odds of being the Democratic Presidential Candidate were 60% on Monday but have fallen to 42% as of this writing. One speaker argued that the “party of chaos” label has moved from the Republicans to the Democrats following the recent presidential debate. Both parties are trying to buy time to get to their respective conventions. July 21 is when the Democrats hold a vote to nominate their candidate formally.

This election is perceived as a referendum on the speed of deglobalization as measured through trade, foreign relations, immigration, and regulation/deregulation.

One question raised was the potential for a tail-risk event in which there was no majority winner of the electoral college vote, similar to the election of 1824. If, on November 5, 2024, the 538 electoral votes were split 269-269, the Twelfth Amendment stipulates that the House of Representatives decides the presidency, and the Senate decides the vice presidency. Imagine a Trump/Harris pairing.

The most common question among attendees was why the capital markets are behaving so well against growing political chaos. According to one presenter, the Treasury market is driven more by system liquidity (Fed’s balance sheet, corporate borrowing, and financial conditions) than by the election. Meanwhile, equity and credit markets, a function of future cash flows, interest rates, and the prevailing economic regime, are already discounting the likely election outcome.

As we recently noted in our mid-year outlook, RiskBridge is watching for investment leadership to rotate away from asset classes that benefit from an economic restart (technology, communications, large-cap, short-duration bonds) to those that benefit from a stagflation-like regime (REITs, commodities, MLPs, mid-caps, longer-duration bonds).
 
What’s on our radar?
RiskBridge’s Composite Risk Index (CRI) is at 0.20, a reading that supports keeping client portfolios fully invested. However, the CRI is rapidly falling. We are closely monitoring funding market liquidity, cross-asset correlations, and economic data (hard & soft) and their potential impact on RiskBridge’s risk and asset allocation models.