In the last few days, the stock markets have adopted the view that with the new head of the Fed, Powell, everything would basically remain the same. Ok, moderate interest rate hikes, but a strong economy, and probably, according to consensus, Powell will be more relaxed about inflation. That’s one of the main reasons for the rally after the hard sell: nothing has changed, the fundamentals are good, the new head of the Fed won’t hurt us. And so a carelessness spreads again, the harsh sale before that is declared as a small industrial accident, which will soon be forgotten.
Maybe that’s true – but maybe not. The fact that the Fed will not be too strict was read by the stock markets, but also by the bond markets, from the statements of James Bullard, head of the St. Louis Fed (who ist not even a voter within the FOMC), who warned against too rapid interest rate hikes. According to Bullard, his biggest worry is that the Fed is making a mistake by raising interest rates too quickly – which suggests that Bullard actually knows that most other Fed members want to raise interest rates faster rather than slower. The markets have not wanted to perceive this dialectic as it seems.
One prefers to let oneself be swept away by statements like yesterday by the new Fed member Quarles, who sees a strong momentum in the US economy due to the US tax reform, but no problem with rising inflation. How an overheating US economy should not form inflationary tendencies, however, remains completely unclear – in most cases the one does not work without the other.
So there is a lot of hope in the market – the hope that, firstly, inflation will not increase despite the highly inflationary policy of the trump administration (import duties, tax cuts, increasing debt, etc.). And secondly, the hope that the Fed put, i. e. the Fed’s readiness to intervene in support of any turbulence on the stock markets, is just as high as it was in the Bernanke/Yellen era. However, if Powell makes it clear today that the Fed’s catching net is considerably lower – not directly under the bottom of the stock markets – it could become critical for the stock markets. When Wall Street was recently hard by the sell off, Fed members like William Dudley seemed to welcome this as a necessary and overdue correction, or as Dudley said literally:”small potatoes”.
The stock markets have been pricing in the last few days for the best of all worlds, they continue to believe in the Goldilock scenario. Powell himself, however, has repeatedly expressed criticism in the past about the fact that the markets would see the Fed as a safety net – he himself is rather market liberal and therefore does not appreciate such safety systems.
However, if Powell were to play the Goldilock scenario today by “talking down” inflation in particular, the markets’ expectations would be met. Would that be another reason to buy? You’d have to wait and see. But should Powell bring a very special touch today, the markets will probably get it on the wrong foot. For this reason, the risk for the equity markets could be higher than the chance of rising at the current level, especially since the US indices such as the S&P 500 in Zone 2790/2810 have now started to meet important resistance!
Either way, this will be an important day today!