Stocks are red. Blame the central bankers? Friday’s speech by Fed Chair Powell was billed as the main event of the week, and markets certainly reacted to it.
Usually we’d pick out one stock to focus on for the week ahead, but that doesn’t seem appropriate right now. Sometimes, the macro outweighs the micro and this may be one of those occasions. Will we see a continuation of the broad-based selling in stock indices such as the SPX500 and the tech-heavy US100?
Take a look at this chart:
A perfect retest of the 20 day moving average from below, and then a big red down day, losing nearly 4% in the aftermath of Powell’s speech. So, what did the Fed Chair say that was so significant?
The speech was titled Monetary Policy and Price Stability. It could have been “Inflation: Nothing else matters”. The core message and conviction was absolutely clear. Inflation is the biggest problem. Come what may, the Fed is committed to bringing it down before expectations de-anchor and everyday life and decisions are influenced by inflation as a permanent feature:
“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions.”
“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. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
Short-term pain for long-term gain. But how short-term will it be? Interest rate markets had been pricing rate cuts for the first half of 2023, betting that the Federal Reserve would stop hiking and almost immediately pivot to bring rates back down.
Powell also pushed back against this interpretation:
Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy. Committee participants' most recent individual projections from the June SEP (Summary of Economic Projections) showed the median federal funds rate running slightly below 4 percent through the end of 2023. Participants will update their projections at the September meeting.
The Fed Chair completed the hawkish message by drawing on lessons from history, particularly the 1970’s era that bears many similarities to the backdrop today. The speech simultaneously noted that they’re aware of the damage of ‘The Great Inflation’ of 1979 (that ended with Volcker’s aggressive two year rate hike cycle from 13.7% to near 20%) while reassuring markets that they will act to avoid a repeat of the same.
As former Fed Chair Alan Greenspan said:
"For all practical purposes, price stability means that expected changes in the average price level are small enough and gradual enough that they do not materially enter business and household financial decisions"
Right now, price stability is way above the Fed’s 2% target, and the commitment was reaffirmed last week. Will stocks retain the same appeal if interest rates increase? If so, which companies will look the most appealing?
The shift is potentially a momentous one. Moving from an era of “free money” (zero or very-low interest rates) to one where money has a cost could redefine how investors allocate their capital.
Not investment advice. Past performance does not guarantee or predict future performance.
