Unexpected Market Volatility After Fed Chairman's Speech
Stock markets responded with volatility to comments made by Federal Reserve Chairman Jerome Powell at the December FOMC meeting. The image shows the markets midafternoon the day following Powell's comments.
Chairman Powell didn't say anything surprising. His speech was almost verbatim to the speech he made two weeks ago at the Washington-based Brookings Institute Hutchins Center for Fiscal and Monetary Policy.
During the meeting, the Fed raised interest rates by 50 basis points (0.50%), as the market overwhelmingly predicted since September. Chairman Powell said what the market expected him to say and did what the market expected him to do. Markets already priced in his comments and rate hike before the conference. Why the volatility?
Why the Volatility?
Every time the Fed hosts an FOMC meeting, they release a document called the Summary of Economic Projections (commonly referred to as "The SEP". The chart contains the numbers most likely to be reported in the media. It compares the numbers to the September predictions. The SEP numbers paint an uncertain future and probably a long-term recession. The market needed time to process the numbers, which led to volatility.
During his remarks, Powell highlighted the expected 2023 core inflation data and terminal interest rate. Watch his speech here or read the transcript here. Chairman Powell talked through the numbers and explained that estimates for 2023 core inflation and Federal funds rate are higher than the September projection. Chairman Powell predicted 3.5% for 2023 core inflation, and the terminal rate would be 5.1%.
During the Q&A, Colby Smith from the Financial Times asked a brilliant question about his statements that seemed to rattle Chairman Powell. "How should we interpret the higher core inflation for 2023 in the SEP? Does that not then suggest that the policy rate currently forecasted for next year should actually be higher than the 5.1 medium estimates penciled in?" Seven of nineteen FOMC participants believe the interest rates should be higher than the projected 5.1%. Seventeen of nineteen believe the interest rate should be higher than 5%.
Several questions remain about much of the data in the SEP. All nineteen participants think inflation errors would be higher inflation, not lower. The 5.1% interest rate is the median expectation, but the upper end of 70% confidence says the Federal Funds rate will be 6.3%.
The margin for error on interest rates is 1.2% and 1.3% for consumer prices. If we calculate the worst-case scenario with today's data, the interest rate could be 7.7% by the end of 2023. 7.7% is unlikely but possible. It seems almost sure the terminal rate will exceed 5.1%, however.
Stock prices reflect expectations of future earnings. The current data is showing interest rates will most likely land somewhere between 5.1%-7.7% in 2023. It isn't easy to predict stock prices if the capital cost is uncertain. All the uncertainty is the reason for today's volatility.
Uncertainty is the argument for owning precious metals. Throughout history, gold has always held value. Gold will always have value whether interest rates go up, down, or sideways. Want some financial certainty if the worst happens?
Call the U.S. Gold Bureau.