Control Panel: Fed acting with resolve

Investment Analysis Clubs Macro Economic Trends and Risks
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All METARs know by now that the Federal Reserve had a meeting on Friday at Jackson Hole, where Fed Chair Powell gave a short, punchy speech. Powell announced that the Fed will stay the course of higher interest rates until inflation is brought down to their target of 2%, despite expected pain for businesses and households. Powell didn’t mention the asset markets but the stock market reacted strongly since speculators had been betting on a Fed pivot away from raising interest rates.

https://www.federalreserve.gov/newsevents/speech/powell20220…
https://discussion.fool.com/powell-trend-change-is-coming-351580…

https://www.wsj.com/articles/stocks-pivot-spurs-investors-to…

**Stocks’ Pivot Spurs Investors to Shore Up Defenses**
**A pronounced retreat from risk following a strong summer rally points to a volatile period ahead, many portfolio managers say**
**By Matt Grossman, The Wall Street Journal, Aug. 28, 2022**

**...**
**Remarks from Federal Reserve Chairman Jerome Powell ended talk of a hoped-for Fed pivot, in which bullish investors bet that falling inflation and a faltering economy would lead the central bank next year to cut interest rates.**

**Instead, it is the stock market that has pivoted. Over two weeks of declines, the S&P has now given up 5.2%, its worst stretch since mid-June. On Friday, bond prices slid, cryptocurrencies fell and every major industry sector posted stock-market losses....**

**Realizing that the Fed is ready to dig in is jarring to investors who were hoping the worst of 2022 was past, analysts and portfolio managers said. Now ahead: more second-guessing of how rising interest rates are likely to hit economic demand, corporate earnings and stock valuations....** [end quote]

Fed Chair Powell said, “We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2 percent. At our most recent meeting in July, the FOMC raised the target range for the federal funds rate to 2.25 to 2.5 percent, which is in the Summary of Economic Projection’s (SEP) range of estimates of where the federal funds rate is projected to settle in the longer run. In current circumstances, with inflation running far above 2 percent and the labor market extremely tight, estimates of longer-run neutral are not a place to stop or pause.”

This key paragraph makes two points that dash cold water over the markets.

  1. The Fed intends to be restrictive until inflation comes down.

  2. Once inflation subsides, the Fed does NOT intend to bring the fed funds rate back to its emergency stimulative level of zero. The Fed intends to return to the historic practice of maintaining a neutral fed funds rate which is 2.25 - 2.5% when the inflation rate is 2%. This permanently shifts the equilibrium back to the historic level, destroying asset values and businesses whose prices were based on the zero fed funds rate (and all the ultra-low rates at other maturities that followed). The Fed is slowly reducing its bloated book of long-term Treasuries and mortgage bonds, which has immediately resulted in a doubling of the 30 year mortgage rate to near its pre-crisis average.

Fed Chair Powell clearly believes that the current inflation resembles the 1970s, which he cited in his speech. “The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.”

It seems that the market is finally beginning to believe what Powell and other Fed officials have repeated over the past 6 months.

https://www.wsj.com/articles/investors-ramp-up-bets-against-…

**Investors Ramp Up Bets Against Stock Market as Summer Rally Fizzles**
**Net short positions against S&P 500 futures have recently grown, reaching levels not seen in two years**
**By Hannah Miao, The Wall Street Journal, Aug. 28, 2022**

**...“Retail investors are actually pretty optimistic,” said Mr. Hackett. “It’s more likely that in the near term, a period where retail investors get more pessimistic causes the market to drop.”** [end quote]

The bottom may take a while until investors realize that the whole playing field has changed.

The Fear & Greed Index has fallen into mild Fear. The trade is suddenly risk-off, not yet severe.

The Treasury yield curve shifted up in the past week, slightly lower at the long end. Financial stress is neutral, nothing to worry about.

The METAR for next week is stormy. Friday’s drop will continue.

Wendy

https://stockcharts.com/freecharts/candleglance.html?VTI,$SP…

https://stockcharts.com/freecharts/candleglance.html?$IRX,$U…

https://stockcharts.com/freecharts/candleglance.html?$SPX,$U…

https://www.cnn.com/markets/fear-and-greed

https://stockcharts.com/freecharts/yieldcurve.php

https://www.financialresearch.gov/financial-stress-index/

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I don’t understand why Wall St. acted like it was blindsided by Powell’s speech?

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I don’t understand why Wall St. acted like it was blindsided by Powell’s speech?

Perhaps, like me, we expected Powell to cave like he did in Dec. 2018. That does not appear to be happening.

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In 2018 there was a lot of political pressure on Powell. In 2022 that does not appear to be the case.

I wonder if he will be judged wrong twice.

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Fed Chair Powell clearly believes that the current inflation resembles the 1970s, which he cited in his speech. “The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.”

I don’t read this as a statement that the nature of today’s inflation per se is the same as the early 1980s, but that (my quote for emphasis) “the Fed’s available policy response today is intended to learn from past policy responses.” Further, the Fed says all the time that their exact policy response will be data dependent. It could high rates, moderate rates, whatever, and higher for longer or higher for shorter. Who knows?

The Fed is not claiming to know their own future path of rate decisions, they want to watch the data month to month.

To make any claims about what the Fed will do and for how long, or what equity markets (rates markets are different) are thinking/assuming right now is just a wild guess by anyone. The Fed knows enough to not emphasize any such guess/forecast, at least not in their public communications.

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Fed Chair Powell clearly believes that the current inflation resembles the 1970s,

Greez little duck, the sky is not! falling!

He absolutely did not say that.
Quoting ; Our monetary policy deliberations and decisions build on what we have learned about inflation dynamics both from the high and volatile inflation of the 1970s and 1980s, and from the low and stable inflation of the past quarter-century. In particular, we are drawing on three important lessons. Nowhere in his statement does he say that today’s economy resembles 1970
You are the only one saying this over and over, And when someone gives you An unbelievable amount of data that discredits this statement you say… I never said that…

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I don’t understand why Wall St. acted like it was blindsided by Powell’s speech?

Wall St. is hyperactive and the more people trade the more money Wall St. makes – coming & going – no refunds.

Just check how hung METaRites are on every word the Fed utters. A tenth of one percent is MACRO and can bring the economy down!!! :wink:

The Captain

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Here’s what I don’t get. I understand raising rates will cause demand to drop. Consumer demand, corporate demand, etc. And that in theory gets demand in synch with supply, and helps price stability. And I know that the only thing the Fed can do is related to rates.

But the problem today IS ONE OF SUPPLY. And it seems nobody is doing anything to solve supply chain issues, etc. etc. etc.

So the Fed is just going to cause a recession to solve inflation, rather than have someone else actually solve the underlying problem, and maybe “fix” inflation w/o putting people out of work?

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So the Fed is just going to cause a recession to solve inflation

Yes

In the most recent statement the federal reserve intends to create unemployment to quell wage inflation.

While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.

“Softer Labor Market Conditions” meaning, high unemployment.
Doesn’t fix anything other than give employers the upper hand to push down wages…

The last time the Fed increased the discount rate, wages stagnanted for the next 16 years. (2001-2017)

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So the Fed is just going to cause a recession to solve inflation, rather than have someone else actually solve the underlying problem, and maybe “fix” inflation w/o putting people out of work?

Yep. They’re going to raise interest rates until inflation stops or unemployment gets too high, whichever comes first. Don’t forget that we have very low unemployment, at least by official numbers. So there’s a lot of room for the Fed to raise rates.

As to someone else doing something to help with the supply side of the economy, that would be Congress. The Fed has no ability to get Congress off their back sides and doing something. The President can do a bit as well. But it seems every time he does do something, half of the country starts kvetching about Presidential overreach rather than complain to their Congress Critters about their inaction. Plus the President’s stop gap measures are usually not going to be as effective as Congressional action.

So for the moment, all we have is the Fed to actually do something. The Fed certainly has a role to play in curbing inflation. But their actions would likely be more effective and less painful if Congress would help as well.

—Peter

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Fwiw, the ECB, after very long hesitation, now seems fully onboard:

The European Central Bank is prepared to at least repeat the half-point increase in interest rates it delivered last month, with an even bigger move not to be excluded as inflation nears yet another record.

That’s the message from ECB officials who joined the Federal Reserve’s annual Jackson Hole symposium, which wrapped up Saturday. …

… whereby, there now appears a move towards ‚frontloading‘ rate hikes, i.e. be bold now, rather than facing justifying further rate hikes at a stage when the economy is already lying on the ground.

In contrast, there is not much discernable action with respect to tapering: https://fred.stlouisfed.org/series/WALCL

https://www.bloomberg.com/news/articles/2022-08-29/ecb-sets-…

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