Powell's speech opens door to Santa rally

The Fed Chair gave a hotly-anticipated speech at the Brookings Institute yesterday. Although there wasn’t much new in Powell’s musings, risk markets rallied regardless. The US100 climbed 4.8%, the SPX500 closed above the 200 day moving average and the US30 entered a ‘new bull market’. Is Santa coming to town?

Two big green days stand out for November as the US tech index looks set to push into the 12000 zone. The first green candle took the index through the 20 day moving average, the second green candle came on the retest of the average (blue line) which has now turned higher:

The 200 day moving average sits 500 points higher. The key trend moving average presented no obstacles for SPX500 yesterday. Santa’s coming to town, cry the bulls.

However, are markets guilty of seeing only what they want to see in Powell’s speech and subsequent comments?

Let’s start with the bull case. Powell didn’t push back against the recent easing in financial conditions. Interest rates are falling, animal spirits are alive and well (evidenced by the stock market reaction), and inflation looks to be softening at a faster pace.

Powell also highlighted the risk management side of the policy changes. The period of 75bps rate hikes at every meeting looks to be relegated to the past:

“Monetary policy affects the economy and inflation with uncertain lags, and the full effects of our rapid tightening so far are yet to be felt. Thus, it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting”

Powell also pointed to the risks of doing too much, too fast:

“My colleagues and I do not want to overtighten because cutting rates is not something we want to do soon. That’s why we’re slowing down and going to try to find our way to what that right level is.”

Interest rate futures are currently pricing the ‘right level’ as ~5% in 2023, a dramatic change for some of the smaller tech stocks formed in the zero rate era. If the Fed’s serious about keeping rates at a higher rate for a longer period, then they could struggle to survive.

‘Higher (rates) for longer’ is the bear case…

The labour market and wages are the keys. Both have been stubbornly strong. In Powell’s words:

“(the labour market) shows only tentative signs of rebalancing, and wage growth remains well above levels that would be consistent with 2% inflation. Despite some promising developments, we have a long way to go in restoring price stability.”

That’s the concern for bulls. Especially the tech upstarts. A higher for longer interest rate regime could starve them of the capital they need to survive. The current yield curve inversion is also suggestive of a recession next year.

Even as it looks like a new bull market could be brewing, there are plenty of risks to the outlook. Disaster may be avoided, but this is no time for complacency.