ORLANDO, Fla. (Reuters) – What many people on Wednesday saw as an open door for Federal Reserve Chairman Jerome Powell appears to be seeing as a potential own goal.
Almost everyone expected him to use his much-anticipated speech on the economic outlook and jobs at the Brookings Institution think tank to roll back the significant easing in US fiscal conditions over the past few weeks.
Looser financial conditions — higher stocks, lower dollar and bond yields, tighter credit spreads — are making it harder for the Fed to succeed in its fight to cool the economy and bring inflation back to target.
They have eased over the past two months, according to Goldman Sachs’ Financial Conditions Index (FCI), despite two 75 basis point rate hikes and promises by Fed officials – including Powell – of further tightening.
They have eased significantly since Wall Street’s cycle low in mid-October and since the Fed’s Nov. 2 monetary policy meeting, leading most observers to believe that Powell would be at least slightly leaning against the markets on Wednesday.
But he refused, and investors were miles away: The S&P 500 and Nasdaq both posted their second-biggest gains in over two years, gaining 3.1% and 4.4%, respectively.
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According to Morgan Stanley, the recovery rally that engulfed risk assets led to the second largest easing in US financial conditions on a year-to-date basis, by 30 basis points.
Goldman’s FCI fell 21 basis points to its lowest level since Sept. 12, mostly led by the move in stocks. As a result of this move, financial conditions are now easier than before the Fed hiked rates in September and November.
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But the truth is, what everyone thought was the right thing for Powell to do on Wednesday — steer the market in the opposite direction — probably wasn’t the right thing, and the Fed chair may have got it just right.
The lagged impact of this year’s 425 basis point rate hikes has yet to be felt in the economy, and the “pain” Powell previously warned about will be felt next year. Several measures of inflation suggest that price pressures have peaked and are now steadily declining.
If all of this is true, there may be less need to focus on financial conditions and more balanced monetary policy now makes sense.
“This is a tacit change of message. We can take this as some evidence that the Fed is ready to accept the easing in financial conditions over the past few weeks,” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management.
BLACKOUT PERIOD
Economic and jobs data this week suggest the Fed’s most aggressive rate-hiking cycle in four decades is beginning to take hold.
The Chicago Purchasing Managers’ Index, a measure of Midwest factory activity, and the national ISM manufacturing index both fell in November to levels typically associated with a recession.
Meanwhile, private sector employment growth across the country was also far weaker than expected last month.
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If these indicators are useful guides to broader trends over the coming months, the Fed is rightly cautious. Powell said Wednesday the Fed has already been “pretty aggressive” and doesn’t want to “crash the economy and clean it up afterward.”
To be clear, the Fed is not completely turning its back on financial conditions. In his Q&A on Wednesday, Powell reiterated his view that a better barometer for policymakers is the extent to which real interest rates are positive.
As a result of this measure, financing conditions have tightened considerably in recent months. Inflation-adjusted Treasury yields hit their highest level in over a decade last month, rebounding sharply from historically negative levels earlier this year.
However, the Fed chairman knows the power of his words. He probably didn’t anticipate such an outsized reaction, but he would have been aware that investors were positioned to combat the recent market rally and significant easing in financial conditions.
Piper Sandler’s economists argue that Powell said nothing new, noting that markets usually recover after his public statements. If the Fed decides to resist the market’s interpretation of its recent comments, it may have to wait.
“The December FOMC blackout period begins Saturday, so the next opportunity for the Fed to update market perceptions again, if necessary, is the FOMC statement and press conference on December 14,” they wrote in a note on Thursday.
(The opinions expressed here are those of the author, a columnist for Reuters.)
Related columns:
– Moving central bank goalposts
– The Fed can denounce the markets to prevent a premature turnaround
By Jamie McGeever; Editing by Andrea Ricci
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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from bias under the Trust Principles.
Jamie McGeever
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