With the inflation outlook becoming more positive, financial markets were hoping the Fed’s next move on interest rates would be less aggressive, but Chair Powell’s particularly blunt and hawkish Jackson Hole speech last Friday signaled otherwise, with the S&P 500 down 3.4% and the Dow down 3% on Friday.
- Powell said: the Fed is responsible for delivering low inflation and it must keep at it until the job is done! It is accepting the consequences that implies (i.e. recession and higher interest rates).
- He added: restoring price stability will require a restrictive policy stance for some time, and another “unusually large” increase in the Fed Funds rate could be appropriate.
- Financial markets now see a 70% chance the Fed will increase the Fed Funds Rate by 0.75% at its September 20-21 meetings. For the Fed to do otherwise, it will need to see a big decline in August inflation and a weaker than expected August jobs number.
How do we square the Fed’s more dovish July FOMC meeting minutes with Chair Powell’s particularly hawkish Jackson Hole speech?
- The Fed has to have credibility in reducing the rate of tightening later this year, and possibly as early as the September meeting, so a full-throttle inflation fighting message was needed.
- For context, Chair Powell’s 2021 Jackson Hole speech explained why inflation wouldn’t last. It used the words “transitory” and “temporary” five times each. It created false confidence that put the Fed behind the inflation curve.
- So even if the Fed agrees with expectations that inflation will come down on its own – as we are starting to see in recent data – it can’t take any chances of being wrong again.
- Energy, food and auto prices have been dropping rapidly and likely will help the August CPI report before the September Fed meeting. In addition, a faster drop in inflation over the next 12 months will also allow the Fed to begin lowering rates in 2023. This will be positive for financial markets.
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