Powell Clearly Told Us That There Was No Fed Pivot
Chair Powell gave his long awaited remarks from Jackson Hole this morning. For Fed chair standards, especially at such a high profile venue like Jackson Hole, Powell’s speech today was short and direct. In fact it was the shortest Jackson Hole speech by a Fed chair (or vice chair) since 2010 and probably well before that.
Source: Piper Sandler Macro Research, Newday Impact
The message was largely as I expected it to be: Inflation is still too high, the Fed is determined to bring it down, and it is willing to tolerate “some pain to households and businesses” in order to do that. In other words, the Fed has not pivoted and likely will not pivot any time soon. In my opinion, Powell was also very clear that the Fed will need to bring policy into “restrictive” territory and leave it there “for some time.” Translated from “Fedspeak”, this means that the federal funds rate will keep going up well beyond current levels and that the Fed has no intention of cutting rates at the first sign of weakness in the labor market or capital markets.
It was also notable that Powell explicitly referenced the lessons learned in the 1970s. In his remarks he clearly stated that central banks should “take responsibility for delivering low and stable inflation,” that inflation expectations cannot be allowed to become unanchored (i.e., that an inflationary mentality cannot become ingrained), and also that the Fed “must keep at it” until the job is done. As I listened, it is clear to me, Powell very much prefers Paul Volcker’s decisive and disinflationary approach to Arthur Burns’ ideas of threading the needle between inflation and the labor market that gave rise to the inflation wave of the 1970s and 1980s. I now have no reason to doubt his resolve.
Powell repeated that the pace of tightening will slow down “at some point,” but he didn’t give the impression that the Fed will revert to traditional 25-bp increments any time soon. In fact, he reminded everyone what he said last month that “another unusually large increase could be appropriate at the next meeting.” He noted the size of the September increase will depend on the totality of the data, but clearly the choice is between 50 and 75 basis points. My base case is now for a 75 basis point increase at the September meeting.
Following the speech, the bond market reaction was to increase the expected trajectory for the funds rate only slightly, but enough to make current expectations the most hawkish since rate hikes started. In fact, the two-year rate broke new highs for this cycle. The market expects a peak rate somewhere in the 3.75-4.00% range by early next year. Judging from what Powell said, risks relative to those expectations appear to be to the upside. In other words, the Fed seems more likely to raise more rather than less. Also, while the market has reduced its rate cuts expectations for next year recently, it still expects the Fed to cut at some point in 2023. However, Powell’s words today suggest that policy will stay in restrictive territory for some time calling that investor assumption into question.
The sharp decline in equity prices today suggests that the stock market might be coming to terms with the Fed being more hawkish. I believe Powell indirectly said that the Fed is willing to accept a recession in order to bring inflation down. The equity market probably counted on the Fed to turn more dovish as the economy softens, and it likely put considerable weight on the possibility of a soft landing. However, I think Powell’s words today reduced the odds of such a benign outcome.
Finally, it is worth noting that the unanimity of view among FOMC member continues. Every single Fed official that spoke this morning on TV provided the same commentary as Powell. The uniformity of views is important because it means there is no opposition to the currently hawkish stance of policy.
BOTTOM LINE: Nobody in the FOMC is pushing for policy to turn more dovish any time soon, and so policy will remain hawkish for the foreseeable future.
This commentary is provided for information purposes only and is not an offer or solicitation of an offer to buy or sell any product or service. Unless otherwise stated, all information and opinion contained in this publication were produced by Newday Funds, Inc. (“Newday Impact”) and other sources believed by Newday Impact to be accurate and reliable. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions about the financial markets, general investment strategy, or particular investments are not recommendations to clients and are subject to change without notice.
Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Past performance does not guarantee future performance.