Ahead of today’s most anticipated market event, Jerome Powell’s speech and Q&A at the Dallas Fed, traders were anxious that the Fed chair would reverse his remarkable hawkishness from mid-September when his suggestion that the Fed may hike rates well beyond the neutral rate sent yields spiking and catalyzed the subsequent market rout. It was not meant to be, and instead during the Q&A portion of his appearance, there were no new signals – or threats – for either the markets or the USD; in fact there was no suggestion that the Fed had any intention of changing its course.
Despite the recent market volatility, ongoing presidential criticism of the Fed’s tightening bath, or the cornucopia of risks at hand – both known and unknown – Powell showed no indication of adjusting the Fed’s gradual approach to normalization of rates and did not provide any new information around the nuances in other policy specifics.
Powell said that he is content with the state of the economy, and was quick to take credit for the ongoing expansion: “I’m very happy about the state of the economy. Our policy is one reason the economy’s in such a good place right now.”
The Fed chair confirmed that the tightening process will go on at a “gradual pace”, saying that the Fed is avoiding “hiking too slowly or too fast” and is taking “both sides seriously so is gradually raising rates.”
Powell also touched on the Fed’s quantiative tightening saying that the “balance sheet unwind is doing very well” and while it is “important to return the balance sheet to a smaller size” he conceded that “we don’t know yet the equilibrium size of the balance sheet”, although it safe to say that said size is not some $3 trillion higher than where it was pre-crisis. Still, one can argue with the semantics considering that despite the Fed’s best intentions, the Fed Funds rate keeps rising to the top of the allotted corridor range and continues to trade on top of the IOER rate (which is likely why the Fed will once again tinker with the IOER increase during the December meeting).
Powell also repeated what he said during Jackson Hole and the last press conference, admitting that the Fed does not know what the neutral rate of interest is, noting that the “debate on the neutral rate is aimed at highlighting risk management.” The comment is seen as intended to keep the market focused on the Fed’s “data dependent” and “gradual” commitments, rather than glued to the dot plot and thinking that the Fed measures “these things with any precision”
The Fed chair also repeated what was previously said in the FOMC minutes, saying that there is a “rising chorus from business on trade”, and warning that a “trade dispute could mean a little higher inflation” and is important to the economy. However, he offset this saying that he keeps a “wait and see” approach, stating that “we don’t see much… it hasn’t shown up in the data.”
There was some caution in Powell’s economist assessment, saying that while “2017 was a strong year for global growth”, there are “growing signs of a bit of a slowdown for 2018” and it is “concerning.” He also listed possible headwinds which include “slowing global growth, less boost from fiscal actions and delayed impact of monetary policy.” However, Powell remains optimistic “that the economy can grow faster, presumably because of higher investment and productivity over time.”
The most interesting part of Powell’s speech was his discussion on the market and the state of housing. On the former, the Fed chair said that “stock market turmoil is something that affects the real economy and financial conditions matter for the outlook”, however before being interpreted as reincarnating the Bernanke/Yellen put, Powell said that the Fed is “looking mainly at the real economy.” In fact, one can almost say that Powell brushed aside the recent market volatility, saying the October episode is just “one of many factors in a very large pod” and that additionally “financial conditions and financial market activity matters a lot for that, and it’s not just the equity market.“
That said, Powell did note that “credit spreads have been very tight”, although largely thanks to GE that now appears to no longer be the case as the market has finally woken up to the risks from record tight spreads within both high grade and high yield names.
If there was one flag of caution in Powell’s entire speech, it had to do with housing which Powell admitted is “slowing” unlike Ben Bernanke who failed to see the biggest housing crash in decades dead ahead of him, but the Fed chair then hedged by saying that its “cyclical impact is less today than in prior years.”
Finally, addressing Trump’s criticism, Powell said that “the Fed’s focus isn’t affected at all by political criticism” and reminded traders that that starting in January 2019 every FOMC decision is “live” for possible rate hikes as there will be a press conferences after each FOMC meeting.
Overall, a quite upbeat presentation by the Fed chair, and if not quite as euphoric as his September speech, it hardly hinted at any dovish shift in the Fed’s posture for the foreseeable future, and certainly silenced those who believe that just because the S&P closed at 2,700 that the Fed will stop hiking.
Or stated otherwise: the Powell “Fed put” is still hundreds of S&P points below the current price.
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