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What Fed Chair Powell’s hawkish turn means for the market, economy

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Jerome Powell, Federal Reserve Chairman, speaks before the Senate Banking Committee hybrid Hearing on the oversight of Treasury Department, Federal Reserve, and Federal Reserve, Capitol Hill in Washington. November 30, 2021.

Elizabeth Franz | Reuters

Stocks are up againOn Wednesday, however, market experts did not find it surprising that the Dow Jones Industrial AverageAfter Monday’s short rally, Tuesday saw new lows. This was before Federal Reserve Chair Jerome Powell shocked the market by speaking more hawkishly in light of the Covid threat.

Monday’s rally didn’t last long: The advance/decline (the ratio of the number of stocks in the market that rose or fell) only barely crossed the 50% threshold. Also, the top winners were all in the tech and defensive sectors rather than wider sector participation. Tuesday saw a reversal. Apple’s outperformanceContrary to almost all other market indicators, this suggested that stock investors were fleeing to safety. This was as close as bond buying gets to the equity market.

Market volatility will increase as the Fed contributes more to it. This is evident from the up-and-down action. Investors should consider these things. Powell’s hawkish messagingBefore the Senate. This indicated that the Fed would discuss speeding up its taper timeline at mid-December and that he believes the term “transitory”, which he used to favor inflation, should be removed from use.

Many theories exist about Powell’s decision to pivot during the new Covid fear cycle. Did it have to do with Biden’s announcement of his re-election as Fed Chair and the fact that he has more power to take action? He is attempting to avoid the tough confirmation hearings that could occur on Capitol Hill. Powell could be using the Omicron version to communicate a more hawkish message? He knows he has the ability to change his tone to be more supportive of the Covid science data.

For now, the market is aware that Powell’s message about inflation and the possibility for an accelerated taper is more hawkish. And if the threat of the omicron does not prove to to be too dire, Powell will have moved from the Fed’s central position to one more in line with what more hawkish Fed members have been declaring for several months.

There’s a possibility that the omicron variation could intensify the supply chain issues the global economy is currently experiencing and increase inflation. This would put pressure on Fed to do more to address inflation threat than new Covid epidemic. Powell and Fed officials have said that the economy is now able to cope with Covid. Each new Covid wave does less harm to the economy.

Powell spoke after a two-day Federal Open Market Committee summer meeting. Powell explained that the economic impact of successive Covid waves in recent months has been less. Powell stated that while we have learned to accept it and many industries have improvised around it.

Powell testified in the Senate this week that the omicron version does have potential complicate the inflation threatInflation being too sticky could be the Fed’s primary fear, even if omicron is proven wrong.

CNBC was provided with many views by experts, both positive and negative, on Powell’s shifting position on taper/inflation.

Fed messaging will be a volatility issue for stocks. 

According to Jefferies chief market strategist David Zervos: “What the markets now are seeing is a preview for a Fed messaging period that could continue adding volatility on top the omicron condition.”

His view is that it will be more challenging to communicate with the central bank as inflation fears increase and there are more changes at key Fed positions. The fact that the event is happening at year end does not make it any easier. Investors are prone to making big selling and buying decisions. S&P 500Investors are either down and cannot afford to take too much risk, and they want to safeguard the downside.

Zervos stated that Friday was “a preview” of the year’s end, adding that the Fed surprise added another dimension to an already volatile stock market period.

Zervos believes investors must understand that even though Powell is the Fed’s chairman, a new Fed is being formed amid inflationary pressures and rigid supply sides. “Combining for what could very well be quite a lot of fireworks.”

While there are many ways to help the Fed changesThey are not on the same scale as a Fed chair; Randy Quarles’ departure is scheduled for year-end; Robert Kaplan, of the Dallas Fed, and Eric Rosengren, of the Boston Fed, resign after controversy about Fed officials trading stock and bond while implementing financial market policies; Richard Clarida’s term expires on January 31st 2022 when he will be replaced by Clarida. expected to be succeeded by Lael BrainardZervos says that all of these issues will create difficult messaging problems for Fed.

He said that Powell and Brainard will be going to Capitol Hill on Tuesday for confirmation hearings. They’ll “get quizzed about everything under the sun,” and there is plenty of opportunity for miscommunication. Zervos suggested that Powell’s hard stance Tuesday might be a way to prepare for “any difficult questions” that may arise from the hearings. We are seeing the Fed move into protection mode, with the new characters. Volatility could still be quite high. 

He stated that while it was clear that the Fed had wrongly forecast inflation for some time now, Powell longer term will prove correct in that inflation will fall and that rates will stay low for longer periods of time. He must be tough with Congress, his boss. That will create room for miscommunication,” said he.

The outlook of the market on rate hikes isn’t changing.

A more hawkish Fed can be a good thing for the economy

Bruce Kasman is JPMorgan’s global economist and head of economic research. He said that investors need to remember, despite the Fed shifting tone, that the economy has been showing strength in the quarter. However, the threat from omicron uncertainty and persistent inflation remain.

Powell’s comments follow a steady stream of Fed speakers who believe the taper should accelerate. The market cannot rule out a Fed moving earlier on rates next year. But part of the reason for a Fed becoming more hawkish is the strength and resilience of the U.S. economic system.

Kasman stated that the Fed was moving “because the economy can handle it.”

It is impossible to incorporate the omicron Wildcard into the economic outlook. However, what is currently showing in the economy right now is an “embarrassing amount of private sector health and pent-up demand.” They are doing a great job. [the Fed]He said that he will accomplish more here than most people anticipate, but it is still reasonable to keep this economy on solid footing.”

Overall, conditions are favorable for an extended period of expansion. For investors in risk assets and equity, it is important to determine whether the economy is able to stay on that recovery path. While a Fed raising rates slightly earlier won’t stop momentum, it will introduce volatility in the near-term.

Kasman stated, “I think the Fed moving sooner and acknowledging how this expansion will be very different from the previous one and will require higher rates…is a positive signal, but it is up to the market to absorb it.”

There are still many interest rates to choose from

No matter if you’re looking at the Fed or omicron, the coming months offer “a broad range of options,” states Meghan Shue of Wilmington Trust Investment Advisors, head of investment strategy.

She believes that “increased optionality” for Fed in its taper timeline is a good thing. Additionally, she pointed out there was already a “loud choir on acceleration of the taper” within Fed.

Shue believes that an earlier taper end will likely mean a earlier rate rise. But, that was the meaning Powell had in his message. Shue explained that it’s the direction of rates hikes that will most matter, rather than when they occur.

She stated that if the market sees an earlier rate rise cycle but lower rates, it will be a positive outcome. An earlier rate hike does not mean that aggressive hiking is possible. This is an environment where the market can do well.”

For now however, volatility will be exacerbated by the market trying to absorb a larger range of options, including the possibility of more Covid cases or a Fed that is more hawkish.

Powell’s timing seems odd but an inflation message has been long overdue

Mohamed El-Erian is the chief economic advisor of Allianz, former CEO of PIMCO. He believes that the Fed must take inflation more seriously and should have communicated the consequences for tapering months before.

He said that Powell’s choice to make this statement at a time when the market was trying to figure out what Covid is, “is interesting.” He said, “I would not have picked it,” but that now was the time to move on to a realistic appraisal of inflation and a more responsive monetary strategy.

El-Erian claimed that central banks all over the world cannot fix supply chain problems or labour shortages. However, what they can do to minimize inflation risk in the face of mounting evidence that inflation has become “deanchored” from their expectations is the fact that El-Erian.

His problem has been that people may wait too long for treatment, and now the Omicron variant is adding to the risk.

El-Erian said, “Waiting to long will lead you into a lose-lose position.”

Powell expressed regret that he didn’t use a large window to adopt a more hawkish approach earlier in the year, despite a strong stock market and record economy, as well as Covid conditions improving.

He stated that inflation was the greatest threat for investors.

Market already expected more Fed volatility

Keith Lerner, Truist chief investment officer, and chief market strategist, was clear that volatility and concerns about Fed tightening would increase market volatility relative to the expectations of investors for much of the last year. But, it would not stop the 2022 equities bull markets.

In an email to CNBC, Powell said, “The comments by Powell complicate this near-term tale.” However, he stated that Powell suggested that it would be appropriate to accelerate the taper, though he did not specify what criteria that should be followed. If we witness a larger market decline, or signs that the micron variant slows economic activity down, it is likely that Fed language will become more dovish.

Lerner believes it’s instructive to reflect on Powell’s 2018 when investors worried that the Fed was operating in autopilot. This caused sharp market declines around the holidays.

Lerner stated, “Learn from this experience and we believe that, if necessary, he will pivot.”  

However, he believes that there are no guarantees in an interim.

Like the market, “The Fed” is still waiting on more details about omicron. As long as there’s clarity, and that they are not changing their stance at the moment, sentiment will be affected and markets will continue to be volatile and headline driven. 

Based on his belief that both corporations and consumers are adapting, that there is still a lot of demand, and that the economy continues to be on solid ground, he remains positive about stocks for 2022. Although we still consider the primary market trend to be higher, it is likely that it will continue to be bumpy in the short-term.”

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