Bottom line The S&P 500 has surged nearly 13% since the beginning of the second quarter, hitting a record high today at 2,876, sparked by powerful second-quarter increases in GDP growth of 4.1% and corporate profit gains of 25%. But amid a fundamental vacuum over the next two months, with market technicians pointing to an ominous double-top from last January’s record high, some investors are bracing for a temporary period of heightened volatility as markets wage a ferocious tug of war between those fundamentals and a carousel of concerns.
These potential headwinds include: uncertain Federal Reserve policy; the Mueller investigation’s growing black swan potential (buoyed by Michael Cohen’s plea deal and Paul Manafort’s conviction for tax and banking fraud); President Trump’s escalating trade and tariff war; and the potentially negative fiscal-policy implications of a “Blue Wave” in the midterm elections.
But Fed Chair Jerome Powell’s first keynote speech this morning at the Fed’s annual monetary policy conference in Jackson Hole, Wyo., was solid. He offered his views on “Monetary Policy in a Changing Economy” and assuaged investor concerns regarding the timing and pace of interest-rate hikes and plans to continue to shrink the Fed’s balance sheet. As a result, we continue to believe that, if equity markets do experience some increased turbulence and a 5% air pocket over the balance of the third quarter, this could represent an attractive buying opportunity, as we reiterate our 3,100 year-end target.
Why is Jackson Hole important? This prestigious monetary-policy symposium, started by the Kansas City Federal Reserve in 1978, draws top central bankers from around the world to discuss important global economic issues. This year’s theme is “Changing Market Structures and Implications for Monetary Policy.”
The current Fed chair enjoys a keynote speaking slot to discuss monetary-policy thoughts and plans. In past years, former Fed Chair Ben Bernanke discussed his plans for “Quantitative Easing 3” and European Central Bank President Mario Draghi outlined his plans for European QE. Last year, Chair Janet Yellen delivered a more academic address that supported the federal government’s increased regulatory footprint.
Dovish speech Powell’s constructive, middle-of-the-road address delivered this morning was in sharp contrast to the Fed staff’s more hawkish study published just yesterday. Powell noted that the U.S. economy has strengthened substantially since the Great Recession, that the unemployment rate has plunged from 10% to 3.9% (near a 20-year low) over this period, and that the Fed’s preferred measure of inflation (core PCE) is running just below its 2% target. Because household and business confidence remain solid, incomes are rising and more fiscal stimulus is coming, Powell said there is good reason to expect that this strong economic performance will continue. As a result, the Fed has gradually raised interest rates and begun to shrink its balance sheet.
Not all milk and honey There are challenges, to be sure, he said, listing the slow growth of real wages for medium- and low-wage workers, a lack of economic mobility, an unsustainably large federal budget deficit, retiring baby boomers and low productivity.
“Two errors that the Committee is always seeking to avoid is moving too fast and needlessly shortening the expansion versus moving too slowly and risking a destabilizing overheating.”
“While inflation has recently moved up near 2 percent, we have seen no clear sign of an acceleration above 2 percent, and there does not seem to be an elevated risk of overheating,” Powell said.
Patience may be a virtue During his speech, Powell praised former Fed Chair Alan Greenspan for his risk-management strategy during a similar economic environment. “Let’s wait one more meeting; if there are clearer signs of inflation, we will commence tightening,” Powell said of Greenspan. Meeting after meeting, as the Greenspan Fed held off on rate increases while believing that signs of inflation would soon appear, inflation gradually declined. That suggests to us that Powell may take more of a patient, wait-and-see approach to counter the perceived inflation risk in hiking rates.
“Not thrilled” President Trump said last week he was “not thrilled” the Fed has continued to hike interest rates. He was hoping for a more accommodative monetary policy that would not serve as a potential headwind to his fiscal-policy initiatives that have boosted economic growth back to a trend line level of about 3%. While Powell did not address Trump’s criticism directly this morning, he said “the Committee’s consensus view is that this gradual process of normalization remains appropriate,” a policy with which the market appears comfortable.
Next stop, Sept. 25-26 The market’s focus will now be the Fed’s next policy-setting meeting in late September, at which we expect another quarter-point rate hike and continued balance sheet shrinkage. There will be a new set of dot plots and a press conference, allowing Powell to detail the Fed’s thinking for the balance of this year and perhaps 2019.
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