Taking a different approach?
Mr. Powell’s deference to financial markets evaporated after the pandemic, to the surprise of many participants, including myself. Despite the equity market sell-off that persisted throughout 2022, and the regional banking crisis that challenged markets in much of 2023, the Fed continued to hike rates. One reason for this rather abrupt shift could be that Mr. Powell does not want to be known as a modern-day Arthur Burns. Mr. Burns, who was Fed chair during the 1970s, is infamous for not keeping rates sufficiently elevated to stem inflation and for letting politics influence the bank’s decisions. History might need some revision. Mr. Burns actually hiked policy rates from 6% to 13% in 1973 – 1974, after which the unemployment rate rose from 4.6% to 9%. I’m not sure any Fed chair would have acted much differently at that time. In any event, Mr. Powell almost certainly does not want his legacy to be that of the leader who destroyed four decades of the Fed’s inflation-fighting credibility. To put an even finer point on it, Mr. Powell is unlikely to seek a third term in 2026, so he is probably intent on restoring price stability in the economy by then.
For all these reasons, I doubt that the 220 bps worth of cuts currently priced by the market for the next 12 months will materialize. Absent a sudden financial crisis, economic data tends to deteriorate gradually and linearly. To create their forecasts, economists extrapolate these trends, and forward-looking indicators for the labor market do point to a higher unemployment rate than in the Fed’s current projections. As noted, however, Mr. Powell has long been skeptical of such prognostications. In his most recent press conference, he acknowledged that the resilience of the US economy in the face of high rates has been surprising, and that historic signals for policy tightness (including Treasury yield-curve inversion and the generally reliable “Sahm rule”) have recently done a poor job predicting recession. Mr. Powell prefers actual, tangible data, and while the July employment report was weak, the Fed views the labor market as being in balance with pre-pandemic rates and at low levels historically.
Monthly Market Review — August 2024
A monthly update on equity, fixed income, currency, and commodity markets.
By
Brett Hinds
Jameson Dunn