It looks like Christmas has come far too early for equities. Led by exchanges primarily in the United States, it appears Santa, in the form of Jay Powell, has been spotted heading down the chimney. It is only December 1st after all so I will stop the parallels between Santa Claus and Federal Reserve Chair Jay Powell before I start picking out who’s Rudolf from his 12-strong band of colleagues known as the Federal Open Market Committee. However, the roots behind what I refer to in this briefing have seemingly reshaped the picture and backdrop of financial markets from FX, through fixed income to equities. Overnight, at what was expected to be a routine event and speech by the central banker, it appears a rather large cat was let out of the bag.
Aside from the usual commentary offered at such events, Powell acknowledged and even hinted towards two things. Firstly, that the Fed was wary of not over tightening rates and secondly, that he thought the economy at least in the US might be capable of a soft landing. These are two pretty run of the mill comments that the market has been debating for some time. However, the Fed just blinked in their game of poker with inflation. Not just blinked in fact, those comments are akin to folding down the corner of the Fed’s hand and showing the suit they’re holding. Unpacking the first comment made: the Fed is wary of not over tightening interest rates. Of course they are, how could they not be, but it is the Fed’s job to tame inflation and one that so far they are only beginning to tame the flames of. It has been a task which will cost billions in interest payments for US citizens and others and has already caused one of the biggest financial shifts we have seen since the 2007/8 financial crisis.
The market has been clamouring for knowledge surrounding when the Fed will stop tightening and when interest rates will peak. By admitting and suggesting that the Reserve are wary of not over tightening they create the expectation they are certainly approaching that phase. Given interest rate expectations are a huge element of the power of their policy tool kit, such comments suggesting a pivot in policy is near can undermine the very expensive and painful policy decisions they have implemented so far. USD weaker on this news, rates markedly lower in the US and stock prices much stronger. As for comment two: the US economy may be capable of a soft landing. Yes, it might. Forecasts show that a recession in the US could be very shallow or eliminated altogether in every sense other than technically with employment and output sustained at pre-Covid levels throughout this cycle. But again: you don’t tell the market that! When you do you improve market and consumer sentiment and confidence artificially over an uncertain future. You change allocative investment and consumption patterns as people build into their financial decisions your rose-tinted spectacle prophesy.
Overall, last night’s speech could have created issues for markets and the economy undermining the ongoing and costly efforts taken to date to bring macroeconomic indicators back to tolerable levels. It also sets a very unstable backdrop for the slew of data that we have inbound today and tomorrow following yesterday’s US labour market data. Today the Fed’s preferred measure of inflation, the PCE deflator, will be observed ahead of tomorrow’s heralded non-farm payrolls employment data. Given the expectations that Jay Powell’s comments last night have fuelled, any surprise readings from either publication today or tomorrow could wrong foot markets, resulting in volatile price action.
Discussion and Analysis by Charles Porter
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