The major talking point today is Jerome Powell’s first testimony to the House Financial Services Committee as Fed Chair… (Unless you’re in London, then it’s probably the few inches of snow that we’ve not seen here in years. This so called “Russian snow storm” still isn’t the -20 degrees centigrade blizzard with record breaking snowfall that it was in Moscow.)
Yesterday, Powell once again outlined recent strength in the US economy, citing particularly that “growth in business investment stepped up sharply last year, which should support higher productivity growth in time.” This of course is what is needed to drive further wage growth, which in turn would add further confidence for the Fed to continue on a path towards normalising rates - assuming the “backdrop of solid growth and a strong labor market” continue. Powell, however, was also clear that “inflation has been low and stable… [and] has continued to run below the 2 percent rate that the FOMC judges to be most consistent over the longer run”. This clarification was followed by multiple clear reminders that the Fed focuses on core PCE, which is “a better indicator of future inflation” and which last read +1.5% yoy in December 2017.
Powell concluded his remarks on the future of rates stating, “In gauging the appropriate path for monetary policy over the next few years, the FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE price inflation to 2 percent on a sustained basis. While many factors shape the economic outlook, some of the headwinds the U.S. economy faced in previous years have turned into tailwinds: In particular, fiscal policy has become more stimulative and foreign demand for U.S. exports is on a firmer trajectory. Despite the recent volatility, financial conditions remain accommodative. At the same time, inflation remains below our 2 percent longer-run objective. In the FOMC’s view, further gradual increases in the federal funds rate will best promote attainment of both of our objectives.”
From these formal comments alone, affirming “further [but] gradual increases in the federal funds rate” and its broader tone, we wouldn’t have expected much of a market reaction or change in number of rate hike expectations for this year. Indeed shortly after the statement US Treasury 10-year yields fell slightly to 2.85%. However as markets digested the full contents of Powell’s comments, including what seemed like a lot of his “personal view[s]” (in contrast to Yellen’s more stalwart approach) both stocks and bonds subsequently sold-off, with the Treasury curve slightly flattening whilst the dollar strengthened. The S&P 500 was down -1.27% and 10-year US Treasury yields now stand at 2.90% (at time of writing), still 5bps off of last week’s highs that followed a higher than expect CPI reading.
We don’t think that 3 hikes this year are now guaranteed (or that 4 hikes are more likely) just because Powell’s “personal outlook for the economy has strengthened since December” but we certainly do agree with much of the Fed’s solid growth and modest inflation outlook. It will be interesting to see how the market deals with a perhaps more expressive Fed Chair, accounting for his almost 6 years in the FOMC but also recognising his weaker background in Economics and monetary policy compared to heavyweights like Yellen (in fact, he’s the first Chair in 30 years not to have a PhD in economics).