On May 3, 2023, Federal Reserve Chairman Jerome Powell announced another interest rate increase of 25 basis points during the May FOMC press conference. The hike was the tenth consecutive rate hike to bring the Federal funds rate to a 16-year high of 5.0-5.25%. Watch the entire speech here.
During the Q&A, Michael McKay from Bloomberg asked about the market pricing in rate cuts before the end of the year. Chairman Powell responded, "We, on the committee, have a view that inflation is going to come down not so quickly, but it will take some time. If that forecast is broadly right, it would not be appropriate to cut rates. We won't cut rates. [sic]"
Stocks responded negatively to Powell’s comments, with both the S&P 500 and DJIA losing more than -0.70%. Regional banking stocks also saw sharp declines following Powell’s comments. The two graphs show the movements of the indices and banking stocks following Powell's statement that the Fed doesn't plan on cutting rates. The banking chart shows the drop since March 10. The final downward dip is following Powell's comments.
He began his speech by speaking about the banking collapses of 2023. Early in the address, Powell stated that the banking industry is "sound and resilient." He also hinted that the banking turmoil could be near the end. Within an hour of the comment, regional banking stocks dropped precipitously.
In after-hours trading, PacWest bank stock continued to fall by more than 50% Wednesday night. Powell’s words seem contradicted by the sharp regional bank losses following his comments about no pivot in 2023. Billionaire investor Jeffrey Gundlach said regional banking troubles would continue until the Fed cuts interest rates.
Powell has repeatedly stated that a rate cut in 2023 is unlikely. Before the meeting, the stock market priced in a rate cut before the end of the year, which is why the indices fell after his comment. Powell repeatedly uses the phrase "adequately sufficient tightening to maintain sustained periods of 2% inflation." He says that before the Fed cut rates, it would need multiple months of data on inflation at 2%—multiple means at least two.
Inflation is currently at 5.6%. Amazingly, 46.2% of the market believes a 25-basis point rate cut will happen at the July FOMC meeting in two months. For the market's expectations and Powell's words to mesh, inflation must drop to 2% today. Who thinks that will happen? Either the market thinks massive bank failures are immediately in front of us, it is lost in wishful thinking, or it expects the Fed to cower to market demands. Whatever the market is thinking, the one sure thing is it expects the Fed to bail it out. The graphic is from the Fed Watch website owned by the CME Group (Chicago Mercantile Exchange).
Readers of this blog have been watching this strange game for months. Powell unequivocally denies a pivot; the next day, the market believes a pivot is coming. Remember this article from October, when the market got it wrong for the 5th time? How about this article from December? Remember in March when Powell testified to Congress to expect higher rates? How about this one from February titled “Market Doesn’t listen as Powell says no rate cut in 2023?”
The point of bringing up the previous articles is to highlight the foolishness of the market. The market is smart for assuming Powell is lying or hiding something but is looking at the wrong statements to determine his truthfulness. The market believes that the lie is that rates will come down. Powell's lie is about how high they could go. In his August Jackson Hole speech, Powell stated, "The Federal Funds Rate will be slightly below 4% until the end of 2023." At the time, the market predicted the terminal rate would be about 4%, then a pivot, and Powell told it what it wanted to hear. The market has been wrong about five or six times about the terminal rate. It’s currently higher than 5%, and Powell again denied a pivot this year.
Powell made it very clear that it was better to overtighten than under because they have tools to reverse course. However, the Fed's primary objective is price stability since unemployment is near all-time lows. Powell's model for success is Chairman Volker's handling of the record inflation in the 1970s and early 1980s. Powell pointed out that due to economic pressure, Volker slowed down raising rates at different times. However, every time he did, it resulted in higher inflation for longer. Volker succeeded when he disregarded political and economic pressures to slow down and committed to getting the job done. Volker raised interest rates to 20%, 6% above inflation.
The Fed must choose between a banking crisis or giving up on its fight against inflation. Either way, the economy is heading toward some unprecedently dangerous waters.
Warning: there are rough waters ahead. It's time to put your life jacket on.
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