Jerome Powell in Jackson Hole
The much-awaited speech from Jerome Powell was a bit of a sleeper. We perceive that Chair Powell intended to convey a well-balanced message, and from our vantage point, he largely succeeded in achieving this objective. Nevertheless, certain market reactions appeared as though he had delivered a speech that leaned toward a slightly hawkish stance. In light of this, equities continued to recover from the recent downward pressure – the Russell 2,000 is down almost 6% over the last month.
Chair Powell’s speech bounced between dovish and hawkish emphasizing the Fed’s continued focus on inflation but shifting towards a more dovish stance when discussing the lagged effects of aggressive monetary policy. In the end, he highlighted that additional rate hikes were on the table if circumstances warranted. One of the key insights derived from the speech included a clear and unwavering commitment to their 2% inflation target. This comes as no surprise to us as the Fed continues to be very focused on anchoring inflation expectations. We also picked up on concerns about the significant uncertainties surrounding the economy’s growth trajectory. But overall, there was a general indication that interest rates are poised to remain elevated for an extended period. This fits with the ‘higher for longer’ theme in the marketplace today.
Our focus remains on the newfound ‘real rate’ dynamic in markets today and the prospects for yield curve normalization. Positive real rates on lower terminal inflation rates make the bond market more interesting today. The very restrictive positive real rates in the front end of the yield curve are very telling of the Fed’s commitment to fighting inflation and facilitating tighter financial conditions. While Powell was very light in his comments about the balance sheet, the reference to a continued unwind seems very logical and consistent to us. QT remains one of the policy tools in the Fed’s back pocket if inflation does not continue to decline. But with this in mind, higher long rates put additional pressure on financial conditions and the overall cost of capital in the system – possibly creating additional issues for markets.
In closing, we believe the backup in yields and the normalization of the curve, make the bond market a more attractive source of insurance against equity and credit volatility, as well as unexpected events that may trigger overall market volatility.
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