Powell vs The US Economy

Jerome Powell gave his testimony at the Senate banking committee yesterday and reaffirmed the Fed’s commitment to bringing inflation down, even as economic activity is ticking higher. Stocks sold off and the dollar strengthened, but were those comments as hawkish as initially perceived?

Here’s the S&P 500:

After falling to the 200 day moving average, the stock index had bounced back. In The Calm Before The Storm, we suggested that the battle between inflation and growth looked set to continue for a while longer. Powell’s comments yesterday pushed stocks down and highlighted the point (emphasis added):

"We will continue to make our decisions meeting by meeting, taking into account the totality of incoming data and their implications for the outlook for economic activity and inflation."

"Although inflation has been moderating in recent months, the process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy. As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes. Restoring price stability will likely require that we maintain a restrictive stance of monetary policy for some time."

Markets cracked on with pricing the odds of higher rates, and are now assigning a 73% chance of a 0.5% (50bps) rate hike at the next Fed meeting on March 23rd according to the CME FedWatch tool:

That’s not all. The peak rate for this cycle is likely to be pushed even higher according to Tim Duy of SGH Macro:

We see the possibility of a 75bp increase in the SEP- implied terminal rate to 5.75-6%. That would imply a policy path of 50-50-25 over the next three meetings and while we can see the possibility of that outcome, it feels like it will be too much of a leap to signal that in the next SEP. The return to 50bp hikes is already a bitter pill for Fed doves to swallow; a full 75bp increase in the terminal rate would be adding insult to injury.

The SEP is the Summary of Economic Projections that the Fed publishes quarterly, and includes the now infamous dot plot. These projections have been getting increasingly hawkish on rates while downgrading prospects for the economy.

Are markets and central banks getting carried away?

There’s a school of thought that Powell wouldn’t have mentioned being “prepared to increase the pace of rate hikes” if they weren’t planning to do so. However, the Fed Chair also said that they’ll be closely monitoring the data and “implications for the outlook for economic activity and inflation”. Is it just a case of maintaining optionality? Walking the walk while hoping the data cracks?

Before the next meeting, there’s today’s US ADP jobs report, JOLTS data, then Non Farm Payrolls on Friday, CPI on March 14th, plus PPI and retail sales on the 15th.

Among those data points, NFP & CPI are likely to be the most impactful. Fed Governor Waller had already laid out his thinking for the Fed’s reaction function a few days earlier:

“If job creation drops back down to a level consistent with the downward trajectory seen late last year and CPI inflation pulls back significantly from the January numbers and resumes its downward path, then I would endorse raising the target range for the federal funds rate a couple more times, to a projected terminal rate between 5.1 and 5.4 percent.”

"On the other hand, if those data reports continue to come in too hot, the policy target range will have to be raised this year even more to ensure that we do not lose the momentum that was in place before the data for January were released."

This is the job creation trend he’s referring to:

The 517k figure was heavily influenced by seasonal factors with many economists and commentators questioning how valid the reading actually was. Consensus looks for around 203k on Friday. Anything less and markets may well undo some of the hawkish pricing and potentially reverse yesterday’s moves...