What’s on the Fed’s mind

Stocks traded higher yesterday, breaking a losing streak as investors were tired of being afraid of what Chairman Powell might say later this morning in Jackson Hole. A revision of last month’s GDP decline showed that the economy did still decline, but not as much – does that even matter?

Wa-choo talkin’ about, Jay? Well, today is the day that Wall Street has been obsessing about all week. Fed Chairman Jerome Powell will finally, finally give his speech at the Jackson Hole Symposium this morning at 10:00 AM Wall Street Time. The question remains will he play “Celebration” by Kool & The Gang or “Burning Down the House” by Talking Heads. Wall Street, in general has been operating under the assumption that the Central Bank will continue to raise rates with a slight preference to slow things down. Why? Well, the Central Bankers said as much in the minutes of their last meeting. Since that time, we got a CPI number that suggested that inflation may have hit its peak. We also got a number that showed that US Unemployment is at multi-decade lows. The first number means that the Fed could possibly slow down the rate hikes and the second is likely to be of concern to the Fed. Sure, low unemployment is good, but in times of high inflation, it could worsen the situation. So, those milestone numbers actually contradict each other when concerning what the Fed may do next. Overhanging all was the GDP print, which was released and revised, showing that the US Economy contracted in Q2. Those releases also came out since the FOMC last sat. The weakened economy should concern the Fed and cause it to play defensive ball. However, given the strong labor market, the Fed may perceive that higher rates may have less of a negative impact on any recession. So, you see that a case can be made for higher faster and for lower slower. That leaves us all in the lurch, and that is precisely why everyone wants to know what the Fed Head might say on the matter.

Jerome Powell believes in forward guidance. He has, for the past several years at the helm of the Fed, used his speaking and official Fed releases to signal to the investment community what the Fed is thinking. This allows markets to adjust prior to policy changes, and in some cases, even change economic conditions. Forward guidance also sends messages to consumers and businesses. The market has grown to expect the Fed to freely signal its intentions at this point. Gone, are the days when the Fed operated like some sort of secret society with its own secret language, only to produce a piece of typewritten paper 8 times a year. That paper would be read in front of cameras, akin to lottery numbers being called. Immediately after, the contents of that paper would be teletyped to all the major news services. Now today, Fed governors are like rock stars, jet setting around the globe to give speeches, get interviewed, and sit on panels, free to give their opinions on the state of the economy and their preference on rate policy. The Chair, himself, presides as the chief telegrapher of Fed intensions. The markets have become accustomed to that sort of treatment…until the last post-FOMC meeting presser at which Powell said that the Fed would not…could not provide any forward guidance at this time. Why? Because the situation is so dynamic, policy changes would have to be made on the fly, in response to the most recent data. While it would be nice to get some level of heads-up from the Fed, we can certainly understand, given the current situation, that the Fed needs to maintain maximum optionality on policy. The Fed’s next policy meeting is a little less than 4 weeks away and Fed Funds futures traders are expecting a +50 basis-point rate hike with a 67% chance of a +75 basis-point bump. That means that the market has factored in a rather aggressive Fed in the near term, but the real question is what the policy makers will do beyond. That is what traders are hoping to glean from today’s speech. However, if you have been reading this note carefully, you would remember that Powell explicitly mentioned that the Fed would temporarily abandon its tell-all policy. If that is still the case, we can expect the chair to say a whole lot of nothing new today. Something like “Inflation is the scourge of the economy, the economy is in OK shape, we are not in recession, labor market is tight, headwinds remain, and it is appropriate to continue to raise interest rates to fight inflation.” He may throw in something akin to “there are signs that our good work is taking effect, but we are far from out of the woods.” I think that by now, all of that is well-known and firmly built into the market. That doesn’t mean that markets will not respond to a nothing-burger with volatility. There is still lots of pent-up fear and elation under the surface of the market. Indeed, there are bulls…AND bears watching from the shadows, ready to strike on the right cue.

YESTERDAY’S MARKETS

Stocks staged a relief rally yesterday after a 3-day losing streak as traders struggle to figure out what Jay Powell might say today. The S&P500 Index rose by +1.41%, the Dow Jones Industrial Average climbed by +0.98%, the Nasdaq Composite Index traded higher by +1.67%, and the Russell 2000 Index advanced by +1.52%. Bonds traded higher and 10-year Treasury Note yields slipped by -7 basis points to 3.02%. Cryptos added +0.15% and Bitcoin slipped by -0.21%.

NXT UP

• In case you haven't heard: Fed Chair Powell will speak this morning at 10:00 AM Wall Street Time.
• PCE Deflator (July) may have slowed to +6.4% from June’s +6.8%. This number is where the real action is, so pay attention to it.
• University of Michigan Sentiment (August) is expected to be revised higher to 55.4 from 55.1.
• The week ahead: More housing numbers, PMIs, Factory Orders, JOLTS Job Openings, and the monthly employment situation. Check back on Monday for calendars and details.