Mr. Powell’s Big Speech

Stocks opened mixed following yesterday’s surprise rally. Currently, the Dow is down 239 points, the S&P 500 is down .2% and the Nasdaq is flat. Comments from Fed Chair Jerome Powell are pushing the dollar & bond yields lower, and commodities higher (see below). Since that speech, the 2-year Treasury yield has dropped to 4.28% from 4.47%. That’s a huge move, and the takeaway is that investors expect lower—not higher—interest rates than they did 24 hours ago.

In a speech yesterday, Fed Chair Powell sounded more conciliatory toward investors than he has been of late. Rather than the bull-in-a-china-shop approach he took last August at Jackson Hole, this time he laid out a scenario whereby he hopes to drive down inflation while avoiding a severe recession. On inflation, he needs “substantially more evidence” to prove that its trajectory is sustainably lower. Specifically, he pointed to Core PCE, which at 5% is stubbornly close to where it was a year ago. But he also acknowledged the time lag between policy actions and economic impact. So while interest rates should still move higher, it now makes sense to moderate the pace of rate hikes. This message and tone were less hard-nosed than expected, which is why bonds and stocks rallied during the last half of yesterday’s the trading session.

Not that everyone believes Mr. Powell’s assertion that a “soft-ish landing” for the economy is possible. It is our sense that most professional investors believe a recession in 2023 is a foregone conclusion. Certainly some prominent indicators—LEI, ISM Manufacturing, inverted yield curve—suggest that. But as CNBC reporter Steve Liesman points out, many of those same investors have been calling for recession for nearly a year, and they keep pushing forward the expected timeline because oddly enough the economy has accelerated during the second half of the year. “All of the people who bet against consumer and corporate resilience…are wrong right now.”

But I think the recession question misses the point regarding Mr. Powell’s speech and its impact on markets. The bottom line is that the Fed won’t blindly charge ahead as aggressively as it has this year, with no regard for the economy and a fixation on one or two inflation indicators. They see the big picture and will at least try to avoid a severe recession. Secondarily, his speech likely gave investors more confidence that the Fed-funds rate won’t have to move higher than about 5%, which is already priced-in to the bond market. That is why we saw bond yields fall afterward.