A day after Powell’s assurances, markets are worried about something breaking

Federal Reserve Chairman Jerome Powell’s insistence that the central bank is not deliberately trying to cause a recession and that the economy is on solid footing is exactly what someone in his position should say.

Problem is, the Fed is likely to go into recession anyway, as the data shows the economy is far from stable.

Consequently, markets tumbled on Thursday, going from a positive reaction on Wednesday to Powell’s post-meeting comments to a defeat as concerns mount over the effect that higher interest rates and tighter monetary policy will have. tight will have in a fragile state of affairs.

“What the market is worried about, even before it goes into recession, is a policy mistake, that the Fed breaks something,” said Quincy Krosby, chief equity strategist at LPL Financial. “The market is also questioning your comment that the economy is strong.”

Federal Reserve Board Chairman Jerome Powell speaks to reporters after the Federal Reserve raised its interest rate target by three-quarters of a percentage point to stem a disruptive rise in inflation, during a news conference following a two-day meeting. of the Federal Open Market Committee (FOMC) in Washington, USA, June 15, 2022.

Elizabeth Frantz | Reuters

More specifically, two comments the Fed chairman made stood out from the press conference: first, that the Fed is not trying to “induce a recession right now. Let’s be clear about this.” Also: “There is no sign of a broader downturn that I can see in the economy.”

In fact, there are myriad signs of slowing down.

On Thursday alone, housing data for May showed a 14.4% monthly slowdown in home construction at a time when there is a chronic housing shortage. A manufacturing reading from the Fed showed continued contraction in the Philadelphia region. Weekly jobless claims were also higher than expected.

That data builds on other recent points: inflation at 41-year highs, consumer confidence at all-time lows and retail spending falling amid dramatically higher prices.

“At the very least, growth would slow down even before the Fed starts slamming on the brakes,” said Tom Porcelli, chief US economist at RBC Capital Markets. “The evidence on this is apparently growing on a pretty consistent basis right now… With all due respect [Powell’s] comment, is simply not consistent with the data on the ground.”

The problem with the solution

After Wednesday’s decision to raise benchmark interest rates by 75 basis points, the biggest move in 28 years, Wall Street’s reaction to the rally, plus Powell’s comments, coalesced around some common themes. .

First, as Krosby said, “the market believes the Fed will eliminate inflationary pressures.”

However, “That’s the problem now. There’s a feeling in the market that it could lead us straight to the Fed breaking something, which is a policy mistake,” she added.

Second, there was a general lack of clarity about what happens next. Will the Fed increase 50 basis points or 75 basis points in July? Powell’s remarks indicated that both are on the table, but his seemingly half-baked comments about the economy left more wiggle room than the markets were comfortable with.

Finally, the president contradicted himself on several occasions.

He noted that the Fed has little control over inflationary inputs such as energy and food prices, but said the Fed will continue to rise until gas prices fall. He also said inflation expectations are well-anchored, while admitting that the policy shift from a half-percentage-point increase to Wednesday’s move was influenced by a rising inflation outlook, as shown in the survey. from the University of Michigan on Friday.

And then there was the economic issue, with the president insisting the economy is well positioned to handle higher rates, while an Atlanta Fed indicator is showing steady economic growth in the second quarter after falling 1.5% in the first. .

A ‘confused’ Fed boss

Taken together, Powell’s comments “seemed confused, lacking in confidence and heightening macroeconomic and financial stability risks,” Bespoke Investment Group said in a note to the client.

The company also criticized Powell for stressing food and fuel inflation, which are generally considered beyond the Fed’s reach.

“Not only is the Fed explicitly targeting the wrong variable and leaving forward guidance aside, they also appear to be very bullish on near-term growth; Powell’s description of consumer spending as ‘strong’ amid ‘no signs of a broader downturn in the economy’ heightens our concern that the Fed is behind the curve and heading for a policy error as a result,” Bespoke said.

Powell said he and his fellow policymakers will not be locked into a specific course of action, but will be guided by data.

He might not like what he sees for a while, particularly if he focuses on inflation influences like gas and groceries.

RBC’s Porcelli said those numbers would likely point to yearly increases of 9% for the rest of the summer, putting the Fed in a potential box if it uses those levels as policy triggers.

“They need an on-ramp. They need to recognize the reality that they can’t control these things,” Porcelli said. “They need to have a better narrative. Apart from him establishing a more cohesive strategy for how they are going to deal with this, it leads to an idea that maybe they make a more significant political mistake.”

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