Federal Reserve Chair Jerome Powell testifies before a Senate Banking Committee hybrid hearing on oversight of the Treasury Department and the Federal Reserve on Capitol Hill in Washington, U.S., November 30, 2021.
Elizabeth Franz | Reuters
on Wednesday, but market experts were not surprised that the tested new lows on Tuesday after Monday’s brief rally, and that was even before Federal Reserve Chair Jerome Powell surprised the market with a more hawkish tone amid the new Covid threat.
Monday’s rally was not made to last: the advance/decline rate (the number of stocks within the market that went up versus down) barely broke the 50% mark, and the winners were all in tech and defensive names rather than broader sector participation. On Tuesday,versus almost everything else in the market suggested a flight to safety among stock investors that was about as close to bond buying as the equities market gets.
The up and down action suggests the market tug of war will continue, and the Fed will now be contributing more to the volatility. So what should investors make ofbefore the Senate, indicating the Fed will discuss accelerating its taper timeline at its mid-December meeting and that the word he has favored on inflation, “transitory” should be retired from usage?
There’s plenty of speculation about why Powell pivoted during a new Covid fear cycle. Was it because Biden announced his reappointment to the Fed chair and he feels more freedom to act? Is he getting ahead of what could be tough confirmation hearings on Capitol Hill? Could Powell be using the omicron variant as an opportunity to send a more hawkish policy message, knowing he can ultimately pull back to a more dovish tone if the Covid scientific data worsens?
What the market knows for now is that Powell’s message on inflation and the potential for an accelerated taper is more hawkish, and if the omicron threat does not turn out to be dire, Powell has moved from the center of the Fed to a position more hawkish members have been stating for months.
There is a risk that the omicron variant intensifies the supply chain issues that the global economy already is experiencing, and the related inflation, which could add pressure on the Fed to act more based on the threat of inflation than a new Covid outbreak it sees the economy as being able to handle. The Fed and Powell are on record as saying the economy has “learned” to live with Covid and each new Covid wave has done less damage to the economy.
“What we’ve seen is with successive waves of Covid over the past year and some months now, there has tended to be less in the way of economic implications from each wave,” Powell said at a press conference that came after a summer two-day meeting of the Federal Open Market Committee. “We’ve kind of learned to live with it, a lot of industries have kind of improvised their way around it,” Powell said.
In his Senate testimony this week, Powell said the omicron variant does potentially, and inflation being sticky may continue to be the main fear of the Fed rather than omicron itself, until proven otherwise.
Experts provided CNBC with a variety of views, both positives and negatives, from Powell’s evolving position on the taper and inflation.
and want to protect to the downside, or investors are down a lot and can’t afford to take a lot of risk.
“Friday was a preview of what happens near year ends,” Zervos said, and the Fed surprise adds another dynamic to what was already poised to be a volatile period for stocks.
Zervos says investors need to understand that a new Fed is in the process of taking shape even with Powell remaining chairman, and amid inflation and more supply side rigidities, “combining for what could be quite a bit of fireworks.”
While theare not on the scale of a new Fed chair, the departure of Randy Quarles scheduled for year end; the resignation of Robert Kaplan of the Dallas Fed and Eric Rosengren of the Boston Fed after controversy over Fed officials trading stocks and bonds while implementing policies that influenced financial markets; and Richard Clarida’s term expiration on January 31, 2022, when he is , all will continue to create “difficult messaging issues” for the Fed, according to Zervos.
And as Powell and Brainard go to Capitol Hill for confirmation hearings and “get quizzed on everything under the sun, it’s just lots of room for miscommunication,” he said. Powell’s tough stance on Tuesday could reflect “prepping for any hard questions that might come from his hearings,” Zervos added. “We’re seeing the Fed kind of move into a bit of protection mode with the new cast of characters and where volatility could remain quite elevated.”
On inflation, he said it has been clear for some time already that the Fed’s original inflation forecast was wrong, but longer-term Powell will be proven right in the sense that inflation will come down, and rates will remain relatively low for a longer period of time, Zervos said. “But he has to look tough ahead of his boss … Congress. And that will set up room for miscommunication,” he said.
. He says there is still a risk that omicron pushes back rate hikes and the market isn’t drawing a straight line between an accelerated taper timeline and rate hike liftoff.
The Fed may be saying that the bond buying simply isn’t helping the economy. But Lee’s view that inflation will cool in 2022 contributes to a belief that central bank policy on the taper will be separate from its rate hike trajectory.
“Powell is catching up to Fed members and acknowledging we won’t see a peak in inflationary pressures in the next month or so, but I don’t think that means we are intractably setting up for higher levels of inflation,” Lee said.
A quicker taper pace could mean it ends by April or May, but thehas declined over the past week in its expectation of a hike in May 2022 from 43% to 40%, and Lee noted the Fed rate forecasting data he watches has not moved in a way that makes him think the rate outlook has changed in any significant way.
this quarter, even though the omicron uncertainty adds a new threat and inflation remains persistent.
Powell’s tone follows a “steady stream of Fed speakers” saying the taper should accelerate and the market can’t rule out a Fed that moves earlier on rates sometime next year, but part of the story behind a more hawkish Fed is the underlying health and resiliency of the U.S. economy.
“The Fed is moving because the economy can handle it,” Kasman said.
The omicron wildcard remains impossible to factor into the economy outlook, but what the economy is showing right now is “an enormous amount of health in the private sector and pent up demand,” he said. “I think what they [the Fed] will do here is more than people expect but quite reasonable for keeping this economy on solid ground,” he added.
The overall environment is setting up for a longer period of expansion, and for investors in equities and risk assets, the most important factor is whether the economy can stay on a recovery path for a long period of time, and a Fed that raises rates a little earlier doesn’t stop that momentum but does introduce more volatility in the short-term.
“I would argue the Fed moving earlier and recognizing how this expansion is very different than the last one and will require higher rates … is a good signal, but the market needs to digest it,” Kasman said.