Federal Reserve Chairman Jerome Powell said in his annual speech at the Monetary Policy Conference in Jackson Hole, Wyoming, that an unexpectedly strong U.S. economy could force the Fed to raise interest rates again. said. This message is not a complete surprise. Thursday morning’s S&P 500 rally turned tumultuous by the close of trading on fears of higher rate hike odds. Stocks rallied modestly on Friday’s opening, but fell after 10-year Treasury yields rose after Powell’s speech.
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Fed Chairman Powell leans toward hawkish
Fed policymakers “are paying attention to signs that the economy may not be cooling as much as expected,” Powell said on Friday, according to a transcript of his speech. “The housing sector is showing signs of picking up,” he said.
At his July 26 press conference after the Fed’s most recent rate hike, Mr. Powell was more balanced.
“We’re at a point where there’s real risk on both sides,” Powell said at the time. This was a notable change from June’s press conference, which indicated policymakers still believed “inflation risks are on the upside.”
Powell’s “double-sided risk” probably meant the risk of inflation remaining high and the risk of the job market weakening more than necessary to keep inflation down.
We believe monetary policy is restrictive and puts downward pressure on economic activity and inflation,” Powell said on July 26.
Powell: Please slow down
In effect, the Fed chair sent the message that the current situation is unsolvable. Rate hikes are likely unless the growth acceleration falters and the still-tight labor market eases further.
“Additional evidence made relentlessly If growth outperforms trend, further progress in inflation could be at risk, warranting further tightening of monetary policy,” Powell said.
He added: “Evidence that tight labor markets are no longer easing may also require monetary policy action. ”
Mr. Powell has also added another factor that makes the Fed wary. ”Inflation is more sensitive to tight labor markets than it has been in decades. ”
Indeed, the Fed’s president stressed that policymakers would “tread cautiously” on whether to raise rates again.
S&P 500 hit by Fed rate hike risk
Markets see another rate hike as the biggest risk to stocks, as an over-tightening Fed could lead to a recession. That risk has increased as U.S. economic growth accelerated in the third quarter and various GDP-tracking indicators show growth of over 3%.
As a result, the market is pricing in the possibility of one more quarterly point rate hike by the Fed. They took steps in that direction before and after Mr. Powell’s speech.As of Friday morning, the market was at about 18% chance of rate hike At the Fed’s September 20 meeting, it rose from 12% on Wednesday. The odds of a rate hike before the November 1 Fed meeting have risen to 51% from 42% on Wednesday.
The concerns, highlighted by lower than expected unemployment claims, could explain why the S&P 500 and Nasdaq reversed their early gains in Thursday’s stock market trading to close 1.35% lower. Helpful. The reversal came despite the market initially welcoming another explosive US earnings report. Nvidia (NVDA).
The S&P 500 was volatile after Powell’s speech on Friday, gaining 0.1%. That was down from 0.4% just before Powell’s speech. The 10-year U.S. Treasury yield rose one basis point to 4.24% after briefly surpassing 4.28%.
Is the era of low inflation over?
This year’s Jackson Hole monetary policy conference seemed designed to be negative for the S&P 500. The theme of the conference, “structural changes in the global economy,” implies that something has changed, but not for the better when it comes to inflation.
Covid-19 supply chain disruptions, fiscal-driven spending spikes, and Russia’s invasion of Ukraine were among the main causes of the worst inflation outbreak in 40 years. But economists have come to believe that other long-term forces play a supporting role. These include deglobalization and onshoring, population aging and the energy transition.
Powell touched only briefly on the question of whether structural changes will require interest rate hikes in the future. While these megatrends help explain the resilience of the economy and the persistence of inflation, there is also a component of federal spending. This equates to nearly $1 trillion in government funding approved through the 2021 Infrastructure Bill and the 2022 Chip and Inflation Control Act.
Outlook for Fed Quantitative Tightening
The possibility of further rate hikes also delays the timing of rate cuts. That’s also a problem for the S&P 500, as the delay in cutting rates suggests the Fed’s unloading of assets bought during the pandemic could continue for some time.
In addition, the minutes of the July 26th meeting, released last week, highlighted another issue. “Many participants noted that the balance sheet drain need not end when the committee finally starts lowering the target range for the federal funds rate.”
If the Fed is cutting rates to prevent a recession, it won’t continue to shrink its balance sheet. But the Fed’s minutes suggested that so-called quantitative tightening could continue. This could happen if the Fed simply cuts rates because the risk of too-high inflation recedes and the economy is healthy.
As a result, recent economic strength has reduced the likelihood of a recession and raised the prospect that the Fed will continue to release up to $95 billion of Treasuries and government-backed mortgage securities each month. And it’s happening amid a glut of Treasuries and a shortage of buyers, helping 10-year Treasury yields rise.
Rise in 10-year Treasury yields pleases Mr. Powell
Fed policymakers believe the job market will need to slow significantly to keep inflation under control.
That’s probably why Fed Chairman Jerome Powell is so happy about the rise in 10-year Treasury yields. This has led to higher mortgage and auto loan rates and squeezed S&P 500 valuations.
High 10-year bond yields are currently a headache for investors. But it could prevent further short-term interest rate hikes and trigger the short-term economic slowdown needed to put the inflation genie back in the bottle.
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