Before the Federal Reserve announced another supersized interest rate hike on Wednesday, investors told Before the Bell they had no problem with the central bank's messaging that it would continue to aggressively fight decades-high inflation.
In fact, they relished it, viewing it as a sign the Fed was taking its job seriously after waiting too long to jump into the fray.
So why did Wall Street cheer Fed Chair Jerome Powell's seemingly dovish turn? The S&P 500 jumped 2.6% on Wednesday, reaching its highest level since early June.
First came the expected. The Fed announced another rate increase of three-quarters of a percentage point, a move that would have seemed unthinkable just six months ago. That will bring the central bank's key rate to a range of between 2.25% to 2.5%, the highest it's been since December 2018.
Among investors, however, attention focused on what comes next. They honed in on comments from Powell during his press conference, which seemed to indicate that the central bank could start to go easier as the US economy slows down.
There appeared to be two pieces of evidence here:
- Powell emphasized that the Fed is moving away from forward guidance, or when it plainly telegraphs to the market what it plans to do next. "We will continue to make our decisions meeting by meeting," he said, noting the Fed will carefully comb through data as it comes in.
- Depending on what this data reveals, Powell said rate hikes could be smaller in magnitude moving forward, as economic growth slows and recession risks rise. "As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases," he said.
The read from markets: Digesting this information, investors decided they had priced in a Fed that was far too tough, and that it could pivot sooner than expected. While there had been fears that if the Fed were to relax a bit, inflation wouldn't be brought under control, this anxiety was put aside.
"This slightest dovish turn was all the market needed to price somewhat looser financial conditions," said Stefan Koopman, senior macro strategist at Rabobank.
Not so fast: Okay, so Wall Street has decided it doesn't actually have a problem with a more chilled-out Fed after all, which could theoretically boost expectations for corporate earnings down the line. But debate is now raging about whether that was actually the correct read of Powell's remarks.
"All Powell could do at the press conference today was talk about how inflation is too high, how the Fed is determined to bring it down, and (implicitly) how he would be willing to tolerate a recession if that's what's needed to get the job done," Piper Sandler's Roberto Perli and Benson Durham told clients. "In other words, the press conference was hawkish."
They have a point. Powell even said that "another unusually large increase could be appropriate" in September if the all-important data supports it.
The bottom line: Uncertainty remains the name of the game. Where some see hawks, others see doves. The through line is that the Fed doesn't really know what it will do next, and markets will remain hyper-sensitive to any commentary in the meantime as it tries to puzzle it out.
What counts as good news and what counts as bad news — well, that may depend on the day. We give up!
Coming up: The first read of US gross domestic product for the second quarter arrives shortly. It could reveal two quarters of shrinking output in a row, which meets one technical definition of a recession.
But Powell stressed that in his view, the US economy isn't experiencing a contraction just yet, especially given the strength of the jobs market.
"I do not think the US is currently in a recession and the reason is there are just too many areas of the economy that are performing too well," he said, adding that the GDP report should be taken "with a grain of salt."
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