A sober Jay Powell on Wednesday delivered a message that scared the markets while serving an important purpose.
Chairman of the Federal Reserve declared the American recovery The profound downturn inflicted by the pandemic had slowed due to a resurgence of the virus and a return to normalcy was still far away for the world’s largest economy.
But its gloomy stance reinforced the Fed’s stubborn determination to continue injecting massive amounts of monetary stimulus into the economy, stifling suggestions that the US central bank could begin to withdraw or “cut” its support by cutting back. so early the volume of its asset purchases. .
“[Mr Powell’s] The mission was to dispel the notion of any early tapering, but in order to do that and justify dispelling the notion of early tapering, he also had to comment on the state of the economy and adopt a cautious tone, “said Jim Caron, a portfolio manager at Morgan Stanley Investment Management. “This added to the already negative sentiment in the market and exacerbated the decline.”
US equities marked their the worst day of the year Wednesday, losses accelerating as Mr Powell spoke. The benchmark S&P 500 closed almost 3% lower, its biggest drop since October.
“Either way, it’s a Catch-22,” Caron added. “If Powell has been overly bullish, the stock markets may have sold further because interest rates may rise sooner and it’s going to be even worse.”
The Fed articulated its pessimistic view of the near-term outlook by acknowledging the recent decline in some economic indicators, which it did not do in its December statement.
“The pace of the recovery in economic activity and employment has moderated in recent months, with weakness concentrated in the sectors hardest hit by the pandemic,” the Fed said.
Mr. Powell then amplified this assessment at his press conference.
“The economy is far from our targets for jobs and inflation, and it will probably take some time for further substantial progress to be made,” he said, adding that it was going to be a “Struggle” to overcome the pandemic by achieving herd immunity through vaccinations.
“We haven’t won this yet, we haven’t managed to do it yet, and we have to stay focused on this as a country,” he said.
The central bank entered difficult ground earlier this month after a handful of Fed chairmen speculated on the Fed’s outlook relax its $ 120 billion monthly asset purchase program starting this year.
The comments rocked complacent investors, who had marked a retirement in 2022, and rekindled painful memories of the “taper tantrum” of 2013 that caused Treasury yields to rise sharply and financial conditions to tighten dramatically around the world.
Mr Powell also addressed this issue directly, saying any discussion of the phase-out was “premature” and promised that any plans to consider an exit strategy would be clearly communicated well in advance.
“[Tapering] is going to be telegraphed really well, ”said Chris McReynolds, head of US inflation trading at Barclays. “They really have no interest in surprising the markets.”
Krishna Guha of Evercore ISI noted that Mr. Powell has also made it clear that the Fed will avoid using monetary policy to choke asset price bubbles, after being squeezed by signs of foamy market valuation during the press conference.
“He has resolutely refused to be distracted from the fundamental macroeconomic objectives of the Fed by what is happening in the casino sector of the stock market,” Guha said. “They keep their eyes on the prize”.
One bright spot was Mr Powell’s insistence that the biggest economic risks were short-term, suggesting confidence in an economic recovery in the second half of the year. But the Fed chairman made it clear that the central bank would not overreact to a rapid improvement, even if it involved a inflation point.
“Frankly, we welcome slightly higher inflation, a little higher. The kind of worrying inflation that people like me grew up with seems unlikely in the national and global context in which we have lived for some time, ”he said.
Mr McReynolds said he believed the Fed would “live up to its word and let things run hot.”
However, the Fed chairman has not entirely ruled out the likelihood that once the recovery is complete, there may still be structural damage to the economy, or at least upheaval that policymakers may need to address.
“We are learning that technology can replace people even more than we thought. As we move into the phase, even after the economy has fully reopened, I think we will still have to keep in mind the people whose lives have been disrupted, ”he said.