Federal Reserve chair Jerome Powell, in his annual Jackson Hole, Wyo., monetary policy conference speech, said the U.S. economy’s unexpected strength could require the Fed to raise rates again. That message isn’t a complete surprise: Concern over rising rate-hike odds helped turn a Thursday morning S&P 500 rally into a rout by the end of the session. Stocks bounced modestly at the open on Friday but faded as the 10-year Treasury yield rose after release of Powell’s speech.
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Fed Chair Powell Tilts Hawkish
Federal Reserve policymakers “are attentive to signs the economy may not be cooling as expected,” Powell said Friday, according to a speech transcript. He noted that the “housing sector is showing signs of picking back up.”
In his July 26 news conference, after the Fed’s most recent rate hike, Powell struck more of a balance.
“We’re coming to a place where there really are risks on both sides,” Powell said at that time. That was a notable change from his June news conference, when he indicated that policymakers still thought “the risks to inflation are to the upside.”
By two-sided risk, Powell likely meant that there’s both risk of inflation staying too hot and of the job market weakening more than is needed to bring inflation down.
Monetary policy, we believe, is restrictive and it is putting downward pressure on economic activity and inflation,” Powell said on July 26.
Powell: Show Me The Slowdown
The Federal Reserve chair essentially sent a message that the status quo won’t cut it. Rate hikes will be likely unless the pickup in growth fades and there’s a further easing of the still-tight labor market.
“Additional evidence of persistently above-trend growth could put further progress on inflation at risk and could warrant further tightening of monetary policy,” Powell said.
He added: “Evidence that the tightness in the labor market is no longer easing could also call for a monetary policy response.”
Powell also added one more seemingly new nugget that is keeping the Fed on its toes. “Inflation has become more responsive to labor market tightness than was the case in recent decades.”
The Fed chief did stress that policymakers “will proceed carefully” on whether to hike rates again.
S&P 500 Hit By Fed Rate-Hike Risk
Markets likely see an extra rate hike as the biggest risk for stocks, because it will raise the chances that Fed overtightening will result in recession. That risk is growing as U.S. economic growth has picked up in the third quarter, with a range of GDP trackers pointing above 3% growth.
That has prompted markets to price in higher odds of one additional quarter-point Fed rate hike. They took a step in that direction ahead of Powell’s speech and after. As of Friday morning, markets now see about 18% odds of a hike at the Fed’s Sept. 20 meeting, up from 12% on Wednesday. Odds of a hike by the Nov. 1 Fed meeting have climbed to 51% from 42% on Wednesday.
That concern, highlighted by lower-than-expected jobless claims, helps explain why the S&P 500 and Nasdaq reversed early gains and closed 1.35% lower in Thursday stock market action. That reversal came despite the market initially cheering another blowout earnings report from Nvidia (NVDA).
Shortly after Powell’s speech on Friday, the S&P 500 turned lower, slipping 0.1%. The 10-year Treasury yield rose 2 basis points to 4.26%.
Is The Era Of Low Inflation Over?
This year’s Jackson Hole monetary policy conference seemed designed to be a downer for the S&P 500. The topic of the conference, “Structural Shifts in the Global Economy,” implies something has changed — and not for the better when it comes to inflation.
Covid-induced supply-chain failures, the fiscally fueled boost to consumption and Russia’s invasion of Ukraine were the major culprits behind inflation’s worst breakout in 40 years. Yet economists have come to think that other, longer-term forces play a supporting role. Those include deglobalization and onshoring, aging demographics and the energy transition.
Powell only briefly touched on the question of whether structural changes will require higher interest rates in the future. While those megatrends help explain the economy’s resilience and inflation’s persistence, there’s a federal spending component also at play. That is the nearly $1 trillion in government funding approved via the 2021 infrastructure bill and the Chips Act and Inflation Reduction Act in 2022.
Outlook For Federal Reserve Quantitative Tightening
The possibility of further rate hikes also pushes back the timing for rate cuts. That’s also an issue for the S&P 500, because delayed rate cuts imply that the Fed’s unloading of assets purchased during the pandemic could go on for a while.
Plus, the minutes of the July 26 meeting released last week highlighted another issue. “A number of participants noted that balance sheet runoff need not end when the Committee eventually begins to reduce the target range for the federal funds rate.”
If the Fed is cutting rates to stave off recession, it won’t keep shrinking its balance sheet. But the Fed minutes indicated that so-called quantitative tightening could continue. That could happen if the Fed is merely lowering rates because the risk of too-high inflation is abating and the economy is sound.
The upshot is that recent economic strength lowers chances of a recession and raises prospects the Fed will continue unloading up to $95 billion in Treasuries and government-backed mortgage securities per month. And that’s happening amid an excess supply of Treasuries and a shortage of buyers, contributing to the higher 10-year Treasury yield.
Rising 10-Year Treasury Yield Pleases Powell
Fed policymakers think that the job market must slow significantly to fully bring down inflation.
That’s why Fed chair Powell is probably pleased about the rise in the 10-year Treasury yield. That is contributing to higher rates for mortgages and auto loans, as well as pinched valuations for the S&P 500.
The high 10-year yield is the current bane of investors. However, that could help avert further short-term rate hikes and engender the near-term slowdown needed to put the inflation genie back in the bottle.
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