Markets crash after Governor Powell’s ‘We must carry on’ speech

With all financial ears tuned and millions of pairs of eyes glued to their screens, market watchers around the world tuned in, as Governor Powell spoke during the first session from Jackson Hole Economic Policy Symposium.

Naturally, high inflation caught everyone’s attention. Similarly, the Fed’s accelerated anticipation of hikes somewhat surprised the markets, with rates jumping 225 basis points in the space of 4 meetings.

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The Governor’s speech summed up in one sentence, you ask? “We must continue.”

It’s true. Chairman Powell strongly reiterated the Federal Reserve’s determination to prioritize price stability and bring inflation closer to its 2% target.

And this despite many mixed economic data. For example, GDP contracted for the second consecutive quarter and the PMI crashed earlier in the week. However, unemployment remained low, the business climate improved and one-year inflation expectations were markedly lower.

Given the moderation in the CPI and stable consumer data, some market watchers believed that Powell and Co. may choose to slow the pace of rate hikes, having already matched the peak of the 2019 cycle.

However, it was clear that the Governor wished to decisively rule out any speculation around a “rapid pivot to rate cuts.”

Labor Market Considerations

The employment situation was a crucial factor in Powell’s ferocity. Unemployment is currently at a half-century low of 3.5%. Interest rate-sensitive sectors such as housing and technology suffered the brunt of the losses, while other areas were relatively immune.

However, policymakers fear that without a return to price stability, labor market conditions are bound to deteriorate.

Powell added that the 2% target would require “sustained growth below trend” and “most likely an easing in labor market conditions.”

If the Fed does not act decisively, higher inflation expectations could materialize, making the task of monetary authorities even more difficult.

Despite the difficulties this would entail, “a failure to restore price stability would entail far greater pain.”

Powell acknowledged that in the past “a long period of very tight monetary policy was ultimately necessary to stem high inflation” but insisted that “our objective is to avoid this outcome by acting decisively now.”

The central bank speaks

Central bank communication remains a mystery shrouded in enigma. Measuring the pulse of the crowd, balancing that with what should be done considering what may happen is a tricky balancing act. An immensely subtle art far from being mastered, the monetary authorities have accumulated the scars of battle much more regularly than the resounding successes delivered with extreme precision.

The world’s largest central bank is also struggling to maintain its grip on the markets.

Today, Powell had the opportunity to exorcise many of his demons, including the reversal of 2019, the insistence on ‘transitional’, the ill-timed policy of average inflation targeting and a near limitless stimulus to the middle of the pandemic.

He chose to talk tough on inflation in order to restore the Fed’s credibility, central to conducting effective monetary policy and managing public expectations.

While broadly in line with expectations in spirit, the market appears to have focused on the challenges expected for homeowners and small businesses in the coming year, and Powell’s comments on the slowdown impending growth. Following this, the Dow plunged more than 1000 stitches. Other major stock indices also fell between 3% and 4% today

But the Fed is credible

Optimistically, one could say that the Fed’s restrictive policy has already started to pay off, with July inflation dipping into the mid-8s.

However, a better month does not make for successful policy, and the FOMC would need to see a lot more evidence of continued price declines before even considering easing. Moreover, it usually takes at least a few quarters for monetary policy to be transmitted to the whole economy.

Andrew Hollenhorst, economist at Citi Noted that the weaker reading may simply be a reaction to cuts to the Medicare program or falling stock prices, which may prove temporary at best.

Although the Governor spoke of a tough game, this narrative was widely anticipated. It remains to be seen if the FOMC can follow through once a deeper downturn sets in.

According to FedWatch CME Toolthe latest data shows that after Jay Powell’s remarks there was a 58.5% chance of a third 75 basis point hike, while a 41.5% chance of a 50 basis point hike basis points.

Interestingly, the CME data also shows that there is a 100% chance that rate hikes will continue without a break until the July 2023 meeting, with a staggering 95.6% chance that the FOMC will rise in the range of 400 to 425 basis points between December 2023 and July 2023. .

In this regard, it would appear that the Fed’s message was largely successful in restoring the Fed’s credibility by convincing the market of its unwavering intentions.

Source: WEC

However, not everyone seems to believe in the Fed’s robust performance, with well-known commentators such as Peter Schiff anticipating a reversal at some point over the next few months.

Personal consumption expenditure

In its latest set of PCE data released by the Economic Analysis Office earlier in the day, consumer spending edged up 0.1%, although data for June was revised down slightly.

The marginal improvement in spending is explained by external factors, in particular the end of the summer holiday driving season which likely freed up household budgets in response to lower gasoline prices.

Annual PCE rose to 6.3%, while core annual PCE (minus food and energy), the Fed’s preferred inflation gauge, rose 4.6% year-on-year , down slightly from the 4.8% recorded in June.

The monthly core PCE fell sharply from 0.6% in June to 0.1% in the latest release.


Despite the moderation in consumption, which accounts for 70% of US economic activity, Q2 GDP remained negative. It contracted 0.6% but improved significantly from the 1.6% drop in the first quarter.

While two consecutive quarters of economic contraction is a dire sign, it should be noted that much of the decline in production was driven by supply-side shocks that caused inventories to swell. Higher inventories squeezed production of intermediate goods, subtracting about 1.3% from overall GDP. (Intermediate goods are not counted as part of GDP.)

Arguably, once supply chain disruptions are resolved, inventory flow should improve significantly. However, given the persistence of bottlenecks so far, it remains to be seen how quickly these can be untangled.

consumer sentiment

The University of Michigan feelings index for August was recorded at 58.2, above both preliminary estimates of 55.1 and considerably better than the July data of 51.5.

Public 1-year inflation estimates came in at 4.8% vs. 5.2% the previous month, a welcome sign for the Fed.

Despite the improving outlook, Powell made it clear now was not the time to hold off on rate hikes while invoking former Chairman Volcker that the central bank needed to “break the grip of inflation expectations.”

Supply side

It should also be noted that the governor himself admitted that central bank policy is demand driven. With much of current inflation resulting from pandemic-era bottlenecks and broken international supply chains, the Fed would likely have to raise rates substantially to bring inflation down significantly, investors like Schiff saying current efforts have been “totally insufficient”.

A recent study by the Federal Reserve Bank of New York valued that 40% of current inflation was supply driven.

Yet, contrary to Stiglitz and Baker’s suggestions, the overall focus seems to remain on demand-side interventions and perhaps not enough on easing supply-side blockages.

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