Well, he did it. Or at least he tried. And, most importantly, it was obvious to market participants that he tried.
“He” is obviously Jerome Powell, and “it” was the successful delivery of an overtly hawkish address at Jackson Hole.
The odds were stacked decidedly against Powell. Nomura’s Charlie McElligott summed it up well. Stocks were predisposed to hearing a “de facto” dovish message due to the precarious balancing act most assumed Powell would attempt to pull off. Headed in, nearly everyone thought he’d “iterate a focus on inflation, while also acknowledging slowing growth and inflation expectations,” with the latter serving as very tentative evidence to support the “past peak” story, Charlie wrote, in a Friday note.
Powell did indeed allude to a decelerating economy, but instead of being juxtaposed with still elevated inflation in typical balance-of-risks fashion, slower activity was contextualized via what he described as a necessary and sustained period of below-trend growth. “These are the unfortunate costs of reducing inflation,” he said.
Read more: The Powell Doctrine
It was a meaningful shift. Powell’s tone was more frank than usual. Stern, even. He was, for the most part, unapologetic. The Fed’s express intent is to engineer a slowdown. They’re “sorry, not sorry,” as it were (that’s not a quote from Powell, the scare quotes are there to distinguish the colloquialism).
As it turns out, the Powell Fed is concerned about how history will remember policy in the post-pandemic era. Previously, that wasn’t clear.
“The reality is, the Fed can’t risk getting ‘Arthur Burns-ied’ and signal any sort of policy easing pivot preemptively — not while inflation tensions are likely to remain structurally present for potentially another year or more,” McElligott said, prior to Powell’s address.
Powell agrees. Wholeheartedly. He repeatedly referenced the mistakes of the 70s and is determined not to repeat them (see what I did there?).
Although it was too early to gather anything like an exhaustive compendium of reactions from across the spectrum of analysts and commentators (it was a Friday in late August, after all), the consensus was as close to unequivocal as can reasonably be expected under the circumstances — much like Powell’s speech.
“‘Powell throws in the towel’,” BMO’s Ian Lyngen and Ben Jeffery wrote, describing a client’s take. “An alternative outcome would have been any sign of caution about the performance of the real economy — which was decidedly not on offer in Wyoming,” Lyngen went on to write, on the way to noting that if the Fed can be taken at its word, they’ll hold terminal “for longer than seen during prior cycles.”
For now, markets will still assign some probability to the commencement of easing in late 2023 (figure below), but to the extent anyone still harbored fantasies about rate cuts early next year, Powell sought to dispense with such notions once and for all.
“The focus of the Committee remains on inflation and inflation alone,” TD’s Oscar Munoz and Priya Misra wrote Friday. “There can be no doubt after Powell’s remarks that the Fed will continue to tighten policy over the coming months.”
They also noted that Powell’s decision to mention longer-run neutral “could suggest that the shorter-term neutral rate may be higher… imply[ing] a higher terminal rate.” In my recap, I wrote that Powell didn’t explicitly instruct markets to lift terminal rate pricing. Maybe he did implicitly, though.
Stocks appeared to get the message. US equities were sharply lower (figure below), while the dollar reversed course to trade higher on the day after what looked like algo-driven oscillations when Powell’s remarks first hit the wires.
He succeeded where he failed in July. This was not the Powell from last month’s press conference. And he was adamant that July’s CPI report was welcome but largely irrelevant unless it’s followed by a long series of similarly benign readings. That seems unlikely, especially if your definition of “benign” includes evidence that inflation is moderating beyond the ebb and flow of volatile energy prices.
My guess would be that stocks aren’t done testing the Fed just yet, notwithstanding Friday’s selloff. At the first real sign of labor market weakness (e.g., a negative payrolls print or even a big downside surprise versus consensus), equities will probably exhibit a “bad news is good news” trade, on the assumption that the Fed’s pretensions to a “hell or high water” stance on inflation are just that — pretensions. If August’s CPI report suggests incremental moderation in price pressures, traders will likewise bet on a reversion to the dovish mean.
“The showdown is with the equities market, which continues to reflexively pull forward easier financial conditions on the expected exit from tightening,” McElligott said, around an hour before Powell strode nervously to the podium (or maybe “took the stand” is more apt).
“As long as he sticks to the Fed’s fairy tale that they can bring down inflation without causing a recession, the markets are likely to cling to the idea that the Fed will cut rates at the first sign of trouble,” Rabobank’s Philip Marey wrote. He mentioned match efficiency, which sounds esoteric, but is in fact a crucial and somewhat lively discussion, as these sorts of debates go. “The claim that wage pressures can be reduced by decreasing the ratio of job openings per unemployed without substantially increasing unemployment is wishful thinking on the Fed’s part,” Marey said. “This ratio is a reflection of job matching which can only be decreased through active labor market policies… outside the scope of the central bank.”
Commenting further in their last remarks before the weekend, BMO’s Lyngen and Jeffery said their confidence in a soft landing “remains low, largely [because] the Fed is not only behind the curve, but also cognizant that there is much credibility rebuilding to be done.” They continued: “It’s not a policy error if Powell knows a recession will be required to anchor inflation expectations.”
Powell made his “a long way” from neutral remark on October 3. By the end of December the Fed started easing. The speech means nothing. You either believe in the Fed is willing to inflict pain on the economy or you don’t. If you do, you’re ignoring decades of precedent.
Fair observation, I don’t doubt the Fed intends to cause some pain if necessary, but I remain skeptic that they will stay course if the pain manifest fast and deep into year end worsening Dems results in the midterms. US tax receipts next year will also be materially lower following this year’s wealth destruction, the administration will face less inflows just as the cost of servicing debt obligations increases, today’s hawkish speech might mean little come 2023.
I wish I lived in this world of wealth destruction and taxes. My portfolio is down along with most others but my investment income will be up 10% this year = more taxes, not fewer. What happens to the stock market doesn’t affect companies unless they are trying to raise money. It will make the rich poorer, but only if they sell. Unrealized losses are only real if one sells. The Feds job is not to make the rich richer.
Kamil, sure, they’ll scurry to the other side of the boat if things change materially in the next few months. BUT, based on this week’s OPEC+ signalling, US crop conditions reports, and LNG price action (both US and EU benchmarks), the question you have to ask is: Are things ACTUALLY going to change materially in the next few months?
I’m not yet convinced that meaningful relief in food, energy and rent is just around the next corner.
We obsess about J Pow’s every word, when we should obsess about futures curves and monthly apartment market surveys.
The question is, suppose over the next few months, monthly inflation remains high AND the job market starts to crumble? Will the Fed fold?
I think Powell has been laying the groundwork for continuing the inflation battle even if people are losing jobs. He was pretty explicit about it today, and was so in July as well.
As for other forms of economic weakness, like stock prices, house prices, consumer spending, profit shotfalls, etc – the Fed would consider those constructive, because it’s been very explicit that “demand”, broadly writ, has to decline.
Those betting on a “Fed put” can still hope for a significant financial system crisis, which I think would force the Fed to back down. Hence, I think, the growing attention to QT, reserves, Treasury liquidity, etc. Most investors (me, anyway) don’t understand the financial plumbing well enough to assess if such a crisis is likely. However, if there’s one thing the Fed has lots of experience with and tools for, it is plugging leaks in the plumbing.
The US is in a ridiculous situation where fiscal policy is creating inflation while monetary policy is trying to correct for the inflationary policies of Biden/Congress.
Midterms should be very interesting.
Emptynester, inflation is global, doesn’t have to do with Biden. If anything, Trump unleashed more inflation with its COVID policies.
It’s amazing to me that out of all the things that have happened in the last six years, over two administrations, some people seem more perturbed about student debt relief than almost anything else. Is it inflationary at the margins? Sure. Maybe. But the estimates of the impact are a rounding error compared to where inflation is right now, and at the end of the day, I honestly have a hard time understanding how folks are so mad about something that has absolutely nothing to do with them. Life isn’t fair. For example, Joe Biden’s first wife and 13-month-old daughter were killed in a car crash. That was really unfair. A lot more unfair than “Oh, gosh, someone else got a break on a loan.” Here’s my advice to folks who’ve spent the last 48 hours pretending to be concerned about the inflationary impact of student debt relief (which may amount to a few tenths of a percentage point) when what they’re really irritated about is someone else’s money: Stop worrying about the next person’s finances. There’s a pop culture term for that. It’s called “pocket watchin’,” and it’s not a compliment. Try this instead: Go find a student, say “Hey, congrats on your windfall!” and then get back to focusing on your own life rather than somebody else’s net worth which, for a ton of the relevant individuals, will still be deeply negative anyway.
Thank you, sir. Well said. When I was a kid growing up I had cousin who always had a better deal than me so I learned that worrying about that wouldn’t make me better off, only what I could do would help me. Amazing, it all came out just fine. All kinds of people had a better deal than me, but many more were worse off. They are my main focus now. My rich cousin doesn’t “do” charity; his nut is too high.
“where fiscal policy is creating inflation while monetary policy is trying to correct for the inflationary policies of Biden/Congress.”
I don’t imagine that the following describes a conscious strategy, but suppose the dichotomy outlined by Emptynester results in lower asset prices (equities, housing, taxes) but higher effective income for the lower paid (wage inflation, social benefits). That might look like a start on reducing the extreme wealth inequality built up over the last few decades.
What one thinks about that may depend on where one sits. I confess to being a little conflicted. But if we’re entering into an era of global populism, as some think, then we might look back at the early 2020s as when the pendulum started reversing.
Don’t fight the fed is what I learned when I missed the 2020 rebound.
H-Man, i was surprised, I thought he would leave the door open by providing hope for equities. He actually did somewhat of a pivot from July by slamming that door shut. I imagine the news over the weekend will portend a weak opening for Monday coupled with September being a not so friendly month for markets, It appears 75 will be a hot topic going into the next meeting.
Powell is a huge fan of Volcker, right? Doesn’t that tell you all you need to know?