Powell Stays the Course Against Inflation

By:

Interactive Brokers’ Senior Economist

Equity markets initially advanced while yields retreated in reaction to yesterday’s Federal Reserve (Fed’s) press release discussing the central bank’s decision to raise the fed funds rate 75 basis points (bps), but subsequent comments from Fed Chairman Jerome Powell quickly trampled optimism that a slowdown in future rate hikes is likely.

The press release explained that future rate changes will be determined by the central bank assessing its “cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Yet Powell quickly dashed hopes the central bank was ready to pivot from its hawkish position when he explained that the Fed’s primary risk is not being aggressive enough. “If we failed to tighten enough, inflation would become entrenched and that would be a much bigger problem, price stability is our bedrock,” he explained. He also maintained that if the Fed tightens excessively, it can use monetary policy loosening tools to support the economy. The Fed, he said, will continue to be forceful but thoughtful in its fight against inflation.

In discussing the Fed’s progress, he explained that the economy is experiencing modest growth in spending and production and that job gains have been robust while unemployment remains low. Inflation, he said, reflects supply and demand issues related to the pandemic, higher prices for food and energy and other broader price pressures. Additionally, the Russia-Ukraine war and Chinese COVID-19 lockdowns are creating additional price pressures.

Powell expressed that it’s very pre-mature to think about pausing rate hikes while also noting that a discussion of slowing the pace of rate hikes may be appropriate at the December or February meetings. He also noted that strength in the labor market and continued hot inflation readings bumped up the Fed’s expectations of the terminal rate, or the peak of where the fed funds rate will end up during the current cycle. Expectations of future rate hikes quickly adjusted higher, with market participants now expecting the fed funds rate to remain at or around 5% through all of next year with a peak at 5.38%.

While some investors were surprised by Powell’s hawkish stance, significant inflationary pressures highlighted in a recent podcast episode and in a commentary yesterday morning have persisted. These pressures, including a hot labor market, wage increases, sticky price increases in the inelastic services segments, combined with geopolitical tensions have been instrumental in the Fed reiterating its hawkish stance after its meeting yesterday.

Powell’s comments yesterday drove selloffs in equity and commodity markets while yields and the dollar climbed aggressively. The 2-year Treasury yield reached a fresh cycle high of 4.74% while the 10-year Treasury yield and the dollar made strong progress toward fresh highs. Equities continued the selloff this morning and major indices are down more than 1% even after yesterday’s plunge of more than 2%.

In other news the British Sterling Pound fell roughly 2% against the dollar as the Bank of England increased rates 75 basis points but led expectations toward a lower terminal rate than previously anticipated.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Interactive Brokers LLC, its affiliates, or its employees.

Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.