Fed’s Powell sparks 1,000-point breakout in Dow. Here’s what investors should do next.

Now might be the time to consider hiding in short-term bonds or corporate bonds and other defensive parts of the stock market.

On Friday, Federal Reserve Chairman Jerome Powell spoke of willingness to cause “some pain” to households and businesses in an unusually blunt speech from Jackson Hole that hinted at a 1970s-style inflation disaster unless the central bank manages to rein in runaway profits that are nearing four-year highs decades.

Reading: Fed’s Powell Says Lower Inflation Will Hurt Households, Businesses In Jackson Hole Speech

Powell’s dovish stance has strategists looking for the best possible plays investors can make, which can include Treasuries, energy and financial stocks and emerging market assets.

The Fed chair’s willingness to break up substantial parts of the U.S. economy to curb inflation “obviously benefits the front end” of the Treasury market, where interest rates are moving higher on expectations of Fed rate hikes, Daniel Tenengauzer said. , head of purchasing strategy for BNY Mellon in New York.

According to him, the yield of the 2-year Treasury TMUBMUSD02Y,
3.384%
hit its highest level since June 14 on Friday, at 3.391%, after Powell’s speech — reaching a level last seen when the S&P 500 officially entered a bear market.

Investors may consider making a play for the front end of the credit markets, such as commercial paper and leveraged loans, which are floating-rate instruments — all of which take advantage of the “clearer direction in the markets right now Tenengauzer said by phone. . He also sees demand for Latin American currencies and stocks, given that central banks in that region are further ahead in rate hike cycles than the Fed and inflation has already started to ease in countries like Brazil.

A Fed battle cry

Powell’s speech was reminiscent of Mario Draghi’s “do whatever it takes” rallying cry a decade ago, when he pledged as then-European Central Bank president to preserve the euro during a full-blown sovereign debt crisis in his region.

Attention now turns to next Friday’s nonfarm payrolls report for August, which economists expect will show an increase of 325,000 jobs after July’s report unexpectedly hot 528,000 reading. Any increase in nonfarm payrolls of more than 250,000 in August would strengthen the Fed’s case for further aggressive rate hikes, and even a gain of 150,000 would be enough to continue rate hikes across the board, economists and investors said.

The labor market remains “out of balance” — in Powell’s words — with demand for workers outstripping supply. August’s jobs data will give a glimpse of how much lower it might go, which would bolster the Fed’s No. 1 goal of reducing inflation to 2 percent. Meanwhile, continued rate hikes risk tipping the U.S. economy into recession and weakening the labor market, while limiting the time Fed officials may have to act forcefully, some say.

“It’s a really delicate balance and they’re operating in a window now because the labor market is strong and it’s pretty clear they have to push as hard as they can” when it comes to higher rates, said Brendan Murphy, head of North America. of global fixed income for Insight Investment, which manages $881 billion in assets.

“All else being equal, a strong labor market means they have to push harder given the context of higher wages,” Murphy said by phone. “If the labor market starts to deteriorate, then the two strands of the Fed’s mandate will be at odds, and it will be more difficult to move aggressively if the labor market weakens.”

Insight Investment has been underweight U.S. and other developed market bonds for some time, he said. The London-based firm is also taking less interest rate exposure, staying in yield curve-flattening trades and selectively overweighting European inflation markets, particularly Germany.

For Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York, the best mix of plays investors could play in response to Powell’s Jackson Hole speech is “to be bullish on materials/energy/banks/ EM option and defense in dividend/low volume stocks (think healthcare)/away from the dollar”.

“Personal Marks”

The depth of the Fed’s commitment to maintain its anti-inflation campaign sank on Friday: Dow industrials DJIA,
-3.03%
sold 1,008.38 points for its biggest decline since May, leaving it, along with the S&P 500 SPX,
-3.37%
and Nasdaq Composite COMP,
-3.94%,
nursing weekly losses. The Treasury curve inverted deeper, to just minus 41.4 basis points, as the 2-year yield climbed to nearly 3.4% and the 10-year TMUBMUSD10Y,
3.042%
it was little changed at 3.03%.

For now, both the inflation and employment sides of the Fed’s dual mandate “point to a tightening policy,” according to Capital Economics senior U.S. economist Michael Pearce. But there are “indicative signs” that the U.S. labor market is starting to weaken, such as an increase in jobless claims compared to three and four months ago, he wrote in an email to MarketWatch. Policymakers “want to see the labor market weaken to help reduce wage growth to rates more consistent with the 2% inflation target, but not so much as to cause a deep recession.”

With the unemployment rate at 3.5% in July, one of the lowest levels since the late 1960s, Fed officials appear to still have plenty of room to advance the fight against inflation. Indeed, Powell said the central bank’s “primary” goal is to return inflation to the 2 percent target, and that policymakers will remain on that task until that is accomplished. Moreover, he said they would use their tools “brutally” to achieve this, and failure to restore price stability would mean more pain.

Front loading hikes

The idea that it might be “wise” for policymakers to preemptively raise interest rates while they still can appears to be what is motivating Fed officials like Neel Kashkari of the Minneapolis Fed and James Bullard of the St. Louis Fed. Louis, according to Derek. Tang, an economist at Monetary Policy Analytics in Washington.

On Thursday, Bullard told CNBC that, with the labor market strong, “it looks like a good time to get in the right neighborhood for the mutual funds rate.” Kashkari, a former dove who is now one of the Fed’s top hawks, said two days earlier that the central bank should push ahead with tighter policy until inflation is clearly down.

Luke Tilley, chief economist at Philadelphia-based Wilmington Trust Investment Advisors, said the next nonfarm payrolls report could be either “high or low” and that still wasn’t the main factor behind the decision. of Fed officials on the size of the interest rate. hikes.

What really matters to the Fed is whether the labor market shows signs of easing from the current headwinds, Tilley said by phone. “The Fed would be perfectly fine with strong job growth as long as it means less pressure on wages and what they want is for there not to be such a mismatch between supply and demand. Recruiting isn’t the big deal, it’s the fact that there are so many jobs available for people. What they really want to see is a mix of weaker labor demand, job cuts, stronger labor force participation and less pressure on wages.”

The week ahead

Friday’s August jobs report is next week’s data highlight. There are no major data releases on Monday. Tuesday brings June S&P Case-Shiller home prices, August consumer confidence, July jobs plus exits and a speech from New York Fed President John Williams.

On Wednesday, Cleveland Fed’s Loretta Mester and Atlanta Fed’s Raphael Bostic speak. The Chicago PMI is also published. The next day, weekly initial jobless claims, S&P Global US manufacturing PMI, ISM manufacturing index and July construction spending data are released, along with more remarks from Bostic. Friday, July sees the release of factory orders and a revision of capital equipment orders.

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