The stock market is down after Jerome Powell’s speech in Jackson Hole. That’s the way the Fed wants it

The stock market’s summer rally ended on Friday as investors digested hawkish comments from Federal Reserve Chairman Jerome Powell at the central bank’s annual conference in Jackson Hole, Wyo.

Powell made it clear that fighting inflation is the Fed’s top priority and that even if some “pain” is required, the central bank will continue to raise interest rates and shrink its balance sheet “for some time.”

The S&P 500 has fallen in all three trading days since the speech and is now down more than 5% from Thursday’s close. The tech-heavy Nasdaq, which is more sensitive to Fed policy, has fallen nearly 7% over the same period.

Paul Christopher, chief global market strategist at Wells Fargo, wrote in a research note on Tuesday that during this summer’s stock market rally investors expected the Fed to “pivot” to rate cuts amid growing recession fears. But Powell’s speech quickly changed that view, sending stocks tumbling this week.

“The message from last week’s global central bank economic symposium in Jackson Hole, Wyoming, was that persistent inflation will require continued aggressive policy in most countries. The Fed’s message for the US was particularly clear on this point,” he wrote.

Throughout 2022, the Fed raised interest rates in an effort to cool the economy and reduce consumer prices, without triggering a recession. But so far, its efforts haven’t made much of a dent, with inflation hovering near a 40-year high last month.

That means the recent drop in the stock market is welcome news to Fed officials who need asset prices to fall if they want to get inflation under control.

Falling stock prices are a sign that the market has gotten the right message: the Fed is focused on inflation above all else, and a tight policy should be expected for at least the rest of the year.

As a result, Fed officials are celebrating the market’s negative reaction to Powell’s comments.

“I was really happy to see how President Powell’s Jackson Hole speech was received,” Neil Cascari, the president of the Minneapolis Federal Reserve Bank, told Bloomberg’s Tracy Alloway and Joe Weisdal on the Odd Lots podcast this week. “People now understand the seriousness of our commitment to bring inflation back down to 2%.

Kashkari pointed out that after the Fed meeting in June, market participants had the wrong idea that the Fed’s anti-inflation measures would remain in place, which led to a roughly 17% rally in stocks from June to mid-August.

“I certainly wasn’t thrilled to see the stock market rally after our last Federal Open Market Committee meeting,” he said. “Because I know how committed we all are to reducing inflation. And in some ways I think the markets have misunderstood that.”

Kashkari is not the first Fed official to stress that asset prices, including stock prices, must fall in order to reduce inflation.

In April, Bill Dudley, the former president of the New York Federal Reserve Bank, wrote an article titled “If Stocks Don’t Fall, the Fed Must Force Them to Fall” in which he explained how part of the Fed’s goal in raising interest rates should be to lower stock prices because they affect how Americans feel about their wealth and, therefore, how they spend.

“One way or another, to get inflation under control, the Fed will need to push bond yields higher and stock prices lower,” Dudley explained.

said Jeffrey Roach, chief economist at LPL Financial Luck that Powell’s speech and comments from current and former Fed officials are evidence of the central bank’s commitment to “keep the bowl off the table.”

Roach’s “bottle punch” metaphor goes back to former Fed Chairman William McChesney Martin, who said in a 1955 speech to the Investment Bankers Association that when the Fed cuts interest rates it is in the position of “the butler who ordered the bowl removed punch just when the party was really heating up.”

Roach argues that the Fed’s efforts to stimulate economic growth over the past decade through interest rate cuts and quantitative easing (QE)—a policy where the central bank buys mortgage-backed securities and government bonds to boost lending and investment—started a party to dangerous assets.

This year, the Fed’s rate hikes ended that party, but investors thought the punchbowl (low interest rates and QE) could return amid recession fears. The Jackson Hole speech made it clear that this is unlikely to happen anytime soon.

While removing the punch bowl may not be good for investors, it may be necessary to lower inflation as the labor market remains hot. Roach noted that, in July, the number of job openings per unemployed person rose near the March peak.

“There are still about two jobs for every person available for work. So for now, the Fed has more reason to keep talking tough about its inflation-fighting mandate,” he said.

Deutsche Bank’s Jim Reid also wrote in a research note on Tuesday that the Fed is trying to avoid “repeating the mistakes of the 1970s” by continuing with aggressive rate hikes until inflation is well under control.

Market weakness following the Fed’s comments is not surprising given this aggressive policy, said David Bahnsen, chief investment officer at The Bahnsen Group, a wealth management firm. Luck.

“The market is grappling with a variety of different headlines from the direction of inflation to the uncertainty of Federal Reserve policy and how corporate earnings will move in the rest of the year and all of these factors are drivers of volatility,” he said. .

Jason Dracho, head of asset allocation at UBS Global Wealth Management, struck a similar tone in a research note on Tuesday, saying investors should prepare for a “high volatility market regime.”

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