Jay Powell on Friday ended any hope that the US Federal Reserve will pull back from dramatic monetary tightening any time soon as he reaffirmed his “unconditional” commitment to tackling high inflation. “The pivot theory has been debunked,” said Brian Kennedy, a portfolio manager with Loomis Sayles. “Powell is a creature of history, and to me this is further confirmation that the Fed doesn’t think inflation is rolling back to 2 percent.” The eight-minute speech sparked a dramatic sell-off in stocks with the benchmark S&P 500 down more than 3 percent — its biggest drop since June’s plunge, when $14 trillion was wiped off the U.S. stock market. Hopes that the Fed might ease its stance as the economy slows have been dashed. All but six of the companies in the stock benchmark fell, with shares of financially sensitive homemakers down nearly 5 percent and chip makers down more than 6 percent. Futures traders changed their bets as well. While they still expect the Fed to raise interest rates between 3.75% and 4% in the first half of next year, they have started to back off their bets that the central bank will start cutting rates later that year and in 2024 as previously . bet. “It couldn’t be clearer that they will continue to raise rates and reduce the balance sheet until they outpace inflation,” said Bob Michele, head of global fixed income, currency and commodities at JPMorgan Asset Management. “This fantasy that they’re going to start cutting rates a few months after the last rate hike is nonsense.” Michele added that the fact that futures and Treasury markets did not react more strongly to Powell’s speech underscored the credibility problem still facing Fed headquarters. Powell and his colleagues have come under fire for arguing last year that inflation would prove transitory and eventually retreat toward the Fed’s 2 percent target. The more muted move in bonds could also reflect the brutal sell-off they’ve already faced this year, money managers said, with the two-year bond yield trading just below a 14-year high hit in June. The market jitters followed Powell’s much-anticipated speech at the first in-person Jackson Hole symposium of global central bankers since the start of the pandemic, in which he said the Fed “must go on until the job is done” on inflation. It also acknowledged that tackling inflation will likely come with economic costs, including a “sustained period of below-trend growth”. “While higher interest rates, slower growth and softer labor market conditions will reduce inflation, they will also bring some pain to households and businesses,” he said. “This is the unfortunate cost of deflation. But a failure to restore price stability would mean much greater pain.” Citing the turmoil of the 1970s — in which the Fed erred by easing policy prematurely to support growth but before inflation had moderated enough — Powell vowed to avoid that outcome. He also reiterated that interest rates should remain at a growth-constraining level “for some time” and highlighted the high bar on economic data to justify a shift to a less hawkish stance. Julian Richters, an economist at Morgan Stanley, said Powell’s speech helped dispel the view that the Fed could be swayed into easing policy as the economy slows. Powell’s comments after the Fed meeting in July helped fuel a relief rally. “This whole talk of the Fed pivoting in July never made sense,” he said. “If you were hanging your hat on the Fed being bullish, this is a course correction.” Fed officials have yet to decide whether a third straight rate hike of 0.75 percentage points is necessary at the next policy meeting in September, or whether they can begin to move away from the “front-loading” phase of the tightening cycle and return to half unit rate increase. In just four months, the federal funds rate rose from near zero to a target range of 2.25 percent to 2.50 percent. Economists believe further rate hikes will be needed in 2023 to tame inflation, which they warn is at significant risk of sticking around longer than expected. Most have entered a recession at some point in the next 12 months, with the unemployment rate rising well past the historic low of 3.5%. “The big unknown is how much the economy will actually slow in the near term and at what point the Fed recognizes that,” Loomis Sayles’ Kennedy said.
