Powell Put in play but greater challenges ahead

Federal Reserve Chairperson Jerome Powell’s pre-prepared opening speech at the Jackson Hole Symposium on Friday afternoon was a key litmus test for the central bank.

Powell took yet another small step towards an eventual tapering this year of the Fed’s asset purchases and a tightening of arguably extremely loose monetary policy while pouring cold water on any talk of policy rate hikes, broadly in line with our expectations.

Price action in US rates, equity and FX markets in the past four days would suggest that Powell has successfully cleared yet another important hurdle.

US Treasury yields across the maturity spectrum are down since Thursday’s close in the bottom half of their post 16th June Fed policy meeting range, the US Dollar has weakened about 0.7% to a 3-week low and the S&P 500 is hovering near a record-high (see Figure 1).

National financial conditions remain very easy and supportive of domestic economic growth. Notably recent market moves have been orderly, with volatility still pretty modest.

The next hurdle for the Fed and financial markets is the 22nd September policy meeting, with the spike in market volatility following the 16th June meeting still fresh in their minds.

We think the Fed will refrain from giving a more specific timeline for the start of its taper and do so only at its 3rd November meeting to retain some data-dependent policy flexibility.

However, we expect the Fed’s updated dot-chart to show a further hawkish shift in terms of the appropriate timing for policy rate hikes. Whether this jars, even if temporarily, with Powell’s disassociation between QE and interest rate policy is open to debate.

We are for now sticking to our core scenario that the Fed will only start hiking its policy rate in 2023 but that the gap between the start of the taper and the start of the rate hiking cycle will be smaller than the 23 months gap in 2014–2015.

Nevertheless, the Fed will want to engineer a slow landing — music to the ears of doves and bulls but arguably a concern for hawks fearful of the Fed and financial markets stalling.

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