- Powell throws the market a bone
- However, he reminds us that the Fed’s work isn’t done
- This is a Fed focused on jobs, jobs and jobs
Today was a good reminder why it’s important you have some market exposure… with all major indices surging post the Fed’s February policy statement.
Those who have long exposure have enjoyed a stellar start to the year.
To be honest, it’s been hard to ‘lose money’ (unless you’re a Permabear).
Jay Powell’s perceived dovishness added fuel to already raging fire.
Now this wasn’t the same Jay Powell from Jackson Hole last year.
He’s long gone.
5 months ago Powell came out swinging… using language like “there will be pain”
Back then, he sounded more like Mr. T from Rocky III
Today Powell hinted the Fed are ‘closer’ to the end… introducing language like disinflation.
He was relaxed and even suggested the Fed may not need to get to “5.0%”
What a difference a few months makes.
What the Fed Offered Today
I took away 5 key things from today’s meeting:
- All about employment;
- Don’t bank on rate cuts this year;
- Growth is slowing – but no recession;
- More signs of disinflation (especially in goods); however
- Still premature to declare victory.
Before I get to each of these… a few words on Powell’s sentiment.
This was a Fed Chairman who felt at ease.
He came across confident that inflation is trending in the right direction – and the Fed’s policy was working.
And to an extent – it makes sense.
For example, consider goods inflation.
Goods have plummeted the past few months… where Powell cited evidence of disinflation (a word not previously used).
And if we also consider we’re about to ‘lap’ exceptionally high year-on-year comparisons… it’s likely inflation will come down.
Therefore, some of Powell’s confidence is understandable.
There are clear signs of meaningful progress.
However, the key is core (services) inflation. And here – Powell reminded us that’s where they are focused.
Which brings me to my first key takeaway… it’s all about jobs.
#1. All About Jobs
This is a Fed almost exclusively focused on the jobs data.
And Powell made that quite clear.
Jobs are the means to the end.
As an aside, this is why I called out unemployment as the most important chart for the year in January.
My feeling was the narrative will move away from all things rates and inflation – and more to the economy (specifically jobs and growth)
As I said in December, the rate cycle is now maturing.
Employment – and specifically wage inflation – will determine whether Powell & Co. are successful in achieving their 2% inflation objective.
Because if service sector inflation remains stubbornly high (e.g. 4%+) – there’s a good chance inflation anchors around this level.
And if that’s the case, expect rates to remain higher for longer.
Which brings us to #2.
#2. Don’t Bank on Rate Cuts
Whilst Powell soothed the market on one hand… he used a bit of the “stick” on the other.
For example, the Chairman said he doesn’t expect rate cuts this year.
Now as we know, this is at odds with the bond market (and specifically the yield on the 2-year treasury).
At the time of writing, we have a 2-year yield trading around 4.10%
However, the Fed funds rate is now 4.75% (and likely heading to 5.00% next month)
Now, with the 2-year at 4.10%, that is the bond market saying to the Fed “your job is done… you don’t need to go any further”
When Powell was challenged on this – he waved it away.
He added:
Given our outlook, I don’t see us cutting rates this year, if our outlook comes true.
Powell also said he was “not concerned” about the bond market implying one more cut before a pause, because some market participants are expecting inflation to fall faster than the Fed does.
“If we do see inflation coming down much more quickly, that will play into our policy setting, of course,”
That said, whilst he said don’t expect cuts… he also took time to throw the market a bone.
And it didn’t take much for the market to bite!
For example, in a response to a question from CNBC’s Steve Liesman, Powell said it is “certainly possible” that the Fed will keep its benchmark interest rate below 5%.
Interesting don’t you think?
For example, his prepared remarks said expect more increases (e.g. implying at least one more).
We’ve raised rates four and a half percentage points, and we’re talking about a couple of more rate hikes to get to that level we think is appropriately restrictive,” Powell said. “Why do we think that’s probably necessary? We think because inflation is still running very hot.”
I would say that our focus is not on short term moves but on sustained changes to broader financial conditions. And it’s our judgement that we’re not yet at a sufficiently restrictive policy stance, which is why we say that we expect ongoing hikes.”
I think this is Powell trying hard to maintain optionality.
For example, he is signalling it has not yet seen enough to weigh a pause and is still oriented towards two further hikes.
However, he is also leaving open the prospect that if we see further disinflation (particularly with core services) – this could give reason for the Fed to pause for the balance of the year.
That said, the market is pricing in what the 2-year is suggesting (i.e. two cuts)
#3. Growth Slowing but No Recession
Part of the ‘means’ to slow inflation is slow the growth in the economy.
Hiking rates and reducing money supply is part of that equation.
Powell said the Fed expects growth to be at a “subdued pace” this year – however didn’t say he expects a recession.
For example, when challenged about the likely prospect of a recession – he said the Fed’s “base case is positive growth this year”
Mmmm…
I translate this as Powell being confident the market will experience a soft landing – with unemployment remaining well below 5.0%
For example, in the Q&A, Powell said the Fed can get inflation back to 2% “without a really significant downturn, or a really significant increase in unemployment.”
And not unlike the comment the Fed ‘may not need to get to 5.0%’ – the market was quick to bite.
We will see… as leading financial indicators suggest otherwise.
#4. Disinflation
I’m not sure the last time we heard the Fed Chair use the word “disinflation”
As I say, Powell used this word several times:
“We can now say I think for the first time that the disinflationary process has started. We can see that and we see it really in goods prices so far”
Yes, goods and commodities are falling.
And those are typically the first two ‘layers’ of the inflation onion to soften.
That said, the Fed was quick to balance this comment with the caveat we are still “very early” in this fight.
And don’t think we have won the war just yet…
Which brings me to #5.
#5. Premature to Declare Victory
Whilst Powell’s overall tone was far less hawkish than many expected – he wasn’t willing to run a victory lap.
“It would be very premature to declare victory, or to think that we’ve really got this.”
100%.
Service sector inflation is still well above the Fed’s target and proving to be stubborn.
For example, whilst it’s a good sign we’re seeing disinflation with goods and commodities – he said “job is not fully done.”
Here Powell cited core services excluding housing – where we are yet to experience disinflation.
I thought this was interesting…
Here Powell went to lengths to nominate something as explicit as “core services excluding housing” – as it tells me what he is watching.
On this, Powell expects inflation to continue moving up in housing services, before moving down.
And if that proves to be correct – then the Fed has every reason to sustain rates in the realm of 4.75% to 5.00% before cutting.
Markets are not pricing in this outcome.
Markets see rates closer to 4.0% by year’s end.
Putting it All Together
This was a very different Jay Powell to what we saw in August.
There was no reference to “pain ahead”…
Instead there were references to “disinflation” and “good signs” inflation is trending in the right direction.
That said, Powell was careful to maintain optionality.
For every dovish remark he was quick to offer the caveat that “inflation is not over, and neither is the Fed’s battle against it.”
At the end of the day, investors will choose what they want to hear.
Did you hear a dove or a hawk?
I heard both.
In closing, it didn’t take much for the market to hear the dovish tones.
And that’s what they wanted to hear.
But let’s see how things go over the coming weeks.
The S&P 500 has now rallied above 4100 and is trading in what I feel will be a general zone of resistance (e.g. up to 4200).
I will be sure to update the charts at the end of the week – once we have had a chance to absorb big-cap tech earnings.
Google, Amazon and Apple are all on tap.