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Wall Street wobbled on less dovish Powell talks

calendar 17/05/2022 - 20:29 UTC

Dow Future jumped almost +568 points from Friday closing levels 3212.00 to a high 32688.00 early U.S. session Tuesday on China’s exit strategy from zero COVID lockdown policies, upbeat report card from Home Depot and Boeing, Musk’s unwillingness to buy Twitter at ‘high prices’ (positive for Tesla) and hopes for a less hawkish Fed talks, especially from Chair Powell at WSJ conclave. Eventually, Wall Street closed in deep green on a trech boost led by Apple, Tesla and Nvidia.

But Dow Future stumbled almost -450 points from the session high soon after upbeat U.S. retail sales data for April, which may pave the way for bigger Fed rate hikes in the coming months. Although Dow Future recovered amid less hawkish talks by Fed’s Bullard and Kashkari, it again slips after Powell said Fed may go above neutral (with bigger rate hikes) if inflation does not come down.

Powell indicated elevated inflation will not come down meaningfully until there is a severe recession (as a result of faster Fed tightening) as-well-as supply chain resolution in China (from zero COVID policy) and Russia/Ukraine (through a peace agreement and withdrawal of economic sanctions). Powell also acknowledged an advanced economy (AE) like the U.S. needs cheaper imported goods/commodities from developing economies like China (Asian exporters) and even Russia (Eastern Europe). It seems that Powell is not so much confident about both (China and Russia's supply chain issues). Thus Fed may have to go for bigger rate hikes even in September, November and December to tame hotter inflation, which may also cause an economic hard landing or even an outright recession.

Highlights of Powell’s Comments:

·         We need to see a convincing reduction in inflation

·         Ongoing rate increases appropriately

·         No one should doubt our resolve to bring down inflation

·         We have the tools and resolve to get inflation back down

·         We know this is a time for the Fed to be laser-focused on bringing inflation down

·         It's been good to see markets reacting to what we are saying

·         We like to work through expectations

·         The markets are pricing in a series of rate hikes

·         The economy is very uncertain, as are outside events

·         It's very difficult to think about giving forward guidance

·         That said if the economy performs as we expect rate hikes will be on the table

·         There is broad support on FOMC for having on table 50 BPS hikes at the next two meetings

·         We need the supply side to have a chance to catch up

·         What we need is to see growth moving down from high levels in 2021

·         Many global events going on that are out of the Fed's control

·         It's been good to see markets reacting to what we are saying

·         We need to see growth moving down to a level that's still positive

·         We need to see clear convincing evidence that inflation is coming down; if we do, can slow the pace of hikes; if we don't see that, we'll have to move more aggressively

·         We need growth to slow so supply can catch up

·         By standards of central bank practice, we move as fast as we have in several decades

·         The underlying strength of the US economy is really good right now

·         The labor market is extremely strong

·         Growth this year is still at very healthy levels

·         Consumer balance sheets are healthy

·         The economy is well-positioned to withstand tighter policy

·         The effects of war & China lockdowns are very uncertain

·         We are raising rates expeditiously to a more normal level

·         We'll probably reach that in Q4 this year, but that's not a stopping point though.

·         We are going to look meeting by meeting, data by data, at financial conditions and economy

·         We don't know where neutral is, or where tight (restrictive) is

·         We need to see clear and convincing evidence inflation coming down

·         We will be looking at our action's impact on the economy

·         We will continue raising rates until we see inflation coming down

·         If we have to go past neutral, we won't hesitate

·         We will go until we are at a place where financial conditions are appropriate, inflation is coming down

·         Financial conditions haven't tightened this swiftly in a long time

·         We will go until we are at a place where financial conditions are appropriate, inflation is coming down

·         It would have been better to raise rates earlier with hindsight

·         You can't get the kind of inflation we have without supply bottlenecks

·         We are now not setting policy on the expectation we get relief from supply-side

·         We didn't see a hit to labor force participation coming

·         The Ukraine war is pushing up commodity prices; we don't know how long that will last now

·         It appears that the effects of the Ukraine war will linger longer than expected

·         The same for China lockdowns, we don't know how long they will impact supply chains

·         There is more demand for workers than people to work by a substantial margin; that means wages moving up at a pace not consistent with 2% inflation

·         We have a job to do on cooling demand

·         We want there to still be healthy wage increases but at a level more consistent with 2% inflation

·         The pathway for the U.S. to use our tools to moderate demand

·         That means wages moving up at a pace not consistent with 2% inflation

·         Meanwhile, we're waiting for the supply side to mend, but there's not much indication of it yet; it's going to be a challenging task to tame inflation

·         There are paths for us to moderate demand, bring inflation back down, and maintain a healthy labor market; it doesn't mean the unemployment rate will stay at 3.6%.

·         Achieving price stability is an unconditional need

·         Still strong labor market if the unemployment rate rises a few ticks

·         There are several viable avenues to a softish landing

·         The economy doesn't work for anybody without price stability

·         That's something we need to do to have a labor market we all want to have

·         A softish landing still is a good landing

·         We don't have precision tools; it is not in any way a surgically precise set of tools that we have.

·         We have to slow growth to achieve a softish landing

·         We think we can maintain low unemployment

·         There could be some economic pain involved to get inflation down; there may be some pain involved

·         The result of our actions may not be a perfect labor market, but will still be strong; we think we can maintain low unemployment

·         In any case, we will achieve price stability

·         It's not impossible to achieve a soft landing but is challenging

·         This is not the moment for nuanced inflation readings

·         We do not see that right now; some signs that are promising on inflation, others not

·         We need to push ahead with rate hikes

·         The market is pricing our thinking pretty well

·         Markets are orderly and functional

·         There are some volatile days and markets but so far I see us getting through this well

·         We want financial conditions to tighten so that supply and demand are better balanced and inflation gets back down

·         There is a risk of sustained labor shortages

·         Right now it feels like the natural rate is well above 3.6%

·         I would love to see a labor market that's more in balance

·         The unemployment rate will shake out where it needs to be

·         There is a real possibility that globalization will go into reverse to some extent

·         We could see higher inflationary pressures for a time, but not necessarily higher inflation as policy would respond

·         There's an overwhelming need to get inflation under control

·         We know what we need to be doing to get inflation under control

·         We need growth to slow so supply can catch up; if we don't see that, we'll have to move more aggressively, if we do, can slow the pace of hikes

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Conclusions: Fed is now preparing the market for bigger rate hikes after July

Wall Street recovered from ‘bigger rate hikes’ panic low after Powell reiterated that Fed has no plan to hike by +0.75% in June and July. Fed will consider at least one-quarter of inflation data and evolving outlook for the next quarter. Thus Powell also didn’t rule out the possibility of +0.75% rate hikes in September, November, and December. Powell clarified that for these three meetings, Fed may hike at lower rates (+0.25%), if core PCE inflation data comes lower than being expected by the Fed, but may also hike at bigger rates (+0.75%) if it comes higher. And if inflation data continues to come as elevated as currently, then Fed will also continue to hike @+0.50% in September, November and December.

Thus, Fed will now watch actual core PCE/CPI inflation data for April-August/September and depending upon the data and evolving outlook may hike by +0.25% (if inflation eases significantly), +0.50% (if inflation does not ease or accelerate significantly) and +0.75% (if inflation accelerates further significantly). Thus the estimated neutral rate may be +2.75% or +3.50% or even +4.25% by Dec’22. But Fed may also front-load a +0.75% rate hike in September, followed by +0.50% each in November and December to reach Bullard’s latest estimate of a neutral rate of +3.75% by Dec’22 as a +4.25% neutral rate may invite another ‘Volcker Recession’, which Biden/Democrats may not allow ahead of Nov’24 Presidential election.

In any way, before Nov’24 election, Biden has to face Nov’22 mid-term election, in which he is set to lose the trifecta. Powell also knows that unless the problem of supply chain distortion and elevated commodity prices normalized because of Russia-Ukraine/NATO geopolitical tensions and economic sanctions, it will be very tough to bring down inflation by solely curtailing demand. This will also result in an economic hard landing/stagflation or even an outright recession, negative for Biden in Nov’22 mid-term election.

Thus Powell virtually called for a resolution of the Russia-Ukraine war. And on Friday, in an unexpected move, U.S. Defence Secretary Austin (who is leading the U.S. proxy war against Russia) called his Russian counterpart and urged for an immediate ceasefire and to keep the communication channel open. This also follows after Russia threatened an all-out Nuclear war (WW III) for U.S./NATO proxy war against Russia by continuous supplies of military equipment, training, and providing mercenaries to fight for Ukraine against Russia.

Despite a die-hard attempt by French President Macron and German Chancellor Scholz for a negotiation/ceasefire between Russia and Ukraine, nothing is happening as Ukraine/Zelensky admin will do nothing without the tacit approval of Biden admin. For any peace/ceasefire agreement between Russia and Ukraine, active participation and willingness of the U.S. are essential. Although Biden will use the anti-Russia narrative in the Nov’22 mid-term election to restore his falling approval rate/popularity, he may not linger Russia-Ukraine war further as it’s already affecting the U.S. as well as the global economy significantly contrary to earlier perception.

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