Translation of Fed-Speak Ends the Summer Rally
Economic data of the past couple of months broadly points to the peak of inflation having been reached. Price weakness in Commodities and Housing, declining CPI/PPI, and an improving supply chain have begun to ease inflationary pressures. While not yet a “Mission Accomplished” moment for the Fed, it’s a healthy beginning to restoring price stability. The market greeted news of Peak Inflation with a media-labeled “summer rally”. We viewed it as a rational bounce off the June lows and an integral component of the market forging a bottom to this bear market. Lowering inflation is a lengthy process, not something akin to hitting a light switch. That’s why the next bull market will almost certainly emerge from the formation of a base rather than the “V” bottom that began the post-COVID advance in 2020.
It goes without saying that reducing inflation comes at a cost. Jerome Powell said it anyway in his speech of last Friday at Jackson Hole when he predicted there would be pain ahead for the economy during this process. The Fed chair further described it as a tempering of GDP Growth, not a killing of demand that would extinguish any expansion of the economy as some analysts translated it to mean. That was all it took to put traders on their heels and head for the exit, dousing the summer rally. Meanwhile, investors with cooler heads and a longer investment horizon stood pat, seeing that a lot has been accomplished. We’ve seen the end of Quantitative Easing, a start to normalizing the Fed Funds rate, a reduction of the Fed Balance Sheet and an unwavering plan to bring inflation down to a desired level over time. Our conclusion: The Jackson Hole speech didn’t imply a forthcoming change in what has been a consistent and successful strategy.
The major points made by Powell last week didn’t deviate from prior statements regarding policy formation. What he said: The FOMC has targeted below-trend GDP growth. The totality of data in the coming months will continue to guide policy formation. They would use their tools to bring demand in balance with supply. The Fed will tighten as long as necessary to accomplish its goal. All that was translated by one game-show host on CNBC as “he wants to break the economy”. That type of rhetoric sells soap, but is otherwise irrelevant to investors.
We and others see a possible tapering of rate increases ahead as the Fed hits full speed in allowing $95 Billion in securities to roll off its balance sheet to the open market each month. That effectively reduces the money supply that fuels inflation and could allow some room for the Fed to be less hawkish through the end of the year in making adjustments to the Fed Funds rate. We anticipate that new data released in advance of the next Fed meeting (Sept. 20-21) will point to inflation expectations easing. We’re among those who look for the FOMC to slow the pace from its two previous 75bp rate hikes and settle on a 50bp adjustment to the Fed Funds rate. Stay tuned.
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