The conference at Jackson Hole is often an academic one. Not so this time. The message was short and came down to one market-oriented message: no pivot!
The Fed chair said that history warns against prematurely loosening policy. Powell signaled that the US central bank will likely keep raising interest rates and leave them elevated for a while to get inflation in line with the 2% target. He pushed back at any idea that the Fed would soon reverse course.
“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance,” Powell said. He also mentioned that restoring price stability will require a “sustained” period of below-trend growth and a weaker labor market. He called the labor market “clearly out of balance” with demand for workers “substantially” exceeding supply.
The message was short and clear and sets the tone for the remaining months of the year.
On the other side of the Atlantic, some ECB members are tinkering with the idea to raise rates in September by 75 basis points due to the deterioration of the inflation outlook. Both major central banks seem ready to fight inflation.
MARKET REACTION
In July, the market priced a Fed pivot for the second half of 2022 with bond yields down and equity prices up significantly. Now, the reaction to the above-mentioned messages was different.
Equity prices in the US and Europe fell and yields as well as corporate spreads moved higher in the Eurozone. The curve flattened in the US and Germany (10y-2y) while Italian spreads rose again, making life even more difficult for the ECB. The Euro initially strengthened significantly but would retreat during a very volatile session.
It seems that the strong move on the stock market witnessed in July remains a bear market rally and therefore, we maintain our prudent stance.
