Despite repeated statements by its members that the public should anticipate an increase of 50 basis points in the Federal Funds Rate on Wednesday, the Federal Open Market Committee hiked the rate by 75bp. It was the largest one-shot increase in rates by the central bank since 1994. The shock from the latest annual inflation rate of 8.6% published the previous Friday left central bankers with no wiggle room. Furthermore, news from across the Atlantic that the United Kingdom and the Eurozone would have to tighten policy in response to surging inflation indicated that inflation was becoming a global phenomenon.
But first, US equities and Treasurys rallied into the market close on Wednesday. Counterintuitive? Contributing to the rise in asset prices was the press conference by Fed Chairman Jerome Powell that followed the FOMC decision. Powell maintained that although there could be another 75bp increase, the norm is likely to be 50bp per meeting. Markets were also somewhat reassured that the Fed was trying to avoid a recession even though the Chairman said at the start of his formal remarks that “we at the Fed understand the hardship high inflation is causing.” After all, unemployment would increase from 3.7% at the end of 2022 to only 4.1% in 2024 according to Federal Reserve calculations.
By the time New York markets opened Thursday, sentiment had turned sharply. Swiss National Bank increased interest rates for the first time since 2007, and the Bank of England instituted yet another rate hike — at the fifth meeting in a row. These developments increased investor concerns that the Fed would have to tighten far beyond levels that Powell had signaled on Wednesday.
Parsing Powell’s statements carefully, investors also found his assertion that the economy was strong to be inconsistent with facts. Just on Wednesday, US Census Bureau figures showed that retail sales had declined by 0.3% month on month in May, compared with a small increase that had been anticipated. That could presage weaker consumer spending accounting for the bulk of US gross domestic product. And on Thursday, before New York markets opened, we learned that housing starts fell by 14.4% in May, the biggest fall since April 2020. These data points suggested that Powell would not meet his stated objective of “2% inflation rate consistent with a strong labor market.”
Further damaging his stance, Powell admitted that “many factors that we don’t control are going to play a very significant role in deciding whether [it is] . . . possible or not” to bring inflation down to the 2% target. If covid waves continue, or if there is no quick end to the Russia - Ukraine war, would that not force the Federal Reserve to put the economy into a serious recession rather than lower inflation with minimal pain as the Chairman had maintained?
A subtle element was probably also behind the market reversal on Thursday. Without ever admitting errors of judgment, Powell is given to shifting positions based on the most recent circumstances. For example, at year-end 2018, he switched from a hawkish position and became a hyper-dove in just a few days in response to a market crash. He has also evolved his thinking from “transitory” inflation last October to something more sustained by November, and from pain-free tightening at the March meeting to forecasting a little bit of pain today. You get the drift.
Simply put, investors decided to bail out of both equities and bonds rather than wait and be confronted with a Woody Allen moment in the movie, Bananas.
Last week’s developments are far more serious than just a one-day rally followed by the next-day drop. Equity and bond investors will not be able to depend on their favorite Uncle Jay to protect their nest egg. His statements of support could get reversed shortly thereafter. Powell Put may be gone for ever but investors will have to live with Powell’s Chairmanship of the world’s largest central bank for at least another 3 1/2 years.
Credibility is a terrible thing to waste!
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
June 18, 2022
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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