A day after Powell’s assurances on the economy, markets fear ‘the Fed is breaking something’


Jerome Powell, chairman of the Federal Reserve’s board of directors, speaks to reporters after the Federal Reserve raises its target rate 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 Reserve. Federal Open Market Committee (FOMC) in Washington, US, June 15, 2022.

Elizabeth Frantz | Reuters

Federal Reserve chairman Jerome Powell emphasizes that the central bank is not deliberately trying to cause a recession and that the economy is on a solid footing, which is exactly what someone in his position would expect.

The problem is that the Fed will go into recession anyway, as data shows the economy is far from stable.

As a result, markets fizzled on Thursday, from a positive response on Wednesday to Powell’s comments after the meeting to defeat as concerns rage over the effect higher interest rates and tighter monetary policy will have on a fragile state. of business.

“What the market is worried about, even before you go into a recession, is a policy mistake, that the Fed is breaking something,” said Quincy Krosby, chief equity strategist at LPL Financial. “The market is also questioning his statement that the economy is strong.”

More specifically, two comments from the Fed chairman stand out from the press conference: First, that the Fed is not trying to “drive a recession now. Let’s be clear about that.” Also, “There is no sign of a broader slowdown that I can see in the economy.”

In fact, there are numerous signs of a slowdown.

On Thursday alone, property data for May showed a 14.4% monthly slowdown in housing starts at a time when there is a chronic housing shortage. A Fed poll of manufacturing showed continued contraction in the Philadelphia area. Weekly unemployment claims were also higher than expected.

That data is piling up on other recent points: inflation at its 41-year high, consumer confidence at an all-time low and falling retail spending amid dramatically higher prices.

“Growth would at least slow even before the Fed puts the brakes on,” said Tom Porcelli, chief US economist at RBC Capital Markets. “The evidence on that now seems to be growing on a pretty consistent basis… With all due respect to” [Powell’s] comment, it’s just inconsistent with the data on the ground.”

The problem with the solution

In the wake of Wednesday’s decision to raise benchmark interest rates by 75 basis points, the biggest move in 28 years, Wall Street’s reactions to the rise, plus Powell’s comments, converged around a few common themes.

First, as Krosby said, “the market believes the Fed is going to ease inflationary pressures.”

“That’s the problem now. There’s a sense in the market that he could lead us straight to the Fed to break 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 statements showed both are on the table, but his seemingly glass-half-full comments about the economy left more leeway than markets trusted.

Finally, the chairman contradicted himself several times.

He noted that the Fed has little control over inflation 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 change from a half-percentage point increase to Wednesday’s move was impacted by rising inflation prospects, according to Friday’s University of Michigan survey.

And then there was the economic issue, with the chairman insisting the economy is well positioned to handle higher interest rates, while an Atlanta Fed index shows flat economic growth in the second quarter after dropping 1. 5% in the first quarter.

A ‘confused’ Fed chief

Taken together, Powell’s comments “came across as confused, lack of confidence and heightened macroeconomic and financial stability risks,” Bespoke Investment Group said in a client note.

The company also hired Powell to focus on food and fuel inflation, which are generally outside the Fed’s purview.

Not only are the Fed explicitly targeting the wrong variable and ignoring the outlook, they also appear far too optimistic about near-term growth; Powell’s description of consumer spending as ‘strong’ amid ‘no sign of a broader economic slowdown “adds to our concern that the Fed is lagging behind and is heading for a policy error as a result,” Bespoke said.

Powell confirmed that he and his fellow policymakers are not locked into a specific course of action, but are guided by data.

He may not like what he sees for a while, especially if he focuses on headline influences, such as gasoline and groceries.

RBC’s Porcelli said those numbers will likely point to a 9% annual increase for the remainder of the summer, putting the Fed in a potential box if it uses those levels as policy triggers.

“They need an exit. They need to recognize the reality that they can’t control this stuff,” Porcelli said. “They need to have a better story. Besides him laying out a more cohesive strategy for how they’re dealing with this, it lends itself to the idea that they might be making a more meaningful policy mistake.”

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