A bit of context is important here. First, post-hike rallies are not that unusual, and the market rallied 2.24 per cent in March when the Fed raised rates by 25 basis points. The next biggest post-hike rally was on March 21, 2000 – Wall Street would go on to lose 40 per cent over the following two years as the dotcom crash ripped through global markets.
You can find a piece of data to illustrate anything, of course. But the point is that rate rises – and particularly the comments that accompany them – do tend to spark reactions that can look silly in hindsight.
While the spectrum of 75 basis point rate increases appears to have been taken off the table, Powell gave no shortage of hawkish signals – as he should with US inflation at 40-year highs of 8.5 per cent.
The most notable was the indication that the Fed may need to go above what is called the neutral rate, where the interest rate is neither encouraging nor discouraging demand; the Fed (and the market) see this as somewhere between 2 per cent and 3 per cent.
“It’s certainly possible we’ll need to move above neutral,” Powell said. “We can’t say that today. We do see restoring price stability as absolutely essential to the economy in coming years.”
The second worry is Powell’s concerns about the US falling into recession. While he painted a scenario where rate rises gently cool the labor market such that it falls back into balance – one job opening for every unemployed person, rather than the two job openings we see now – he admitted such a soft landing “won’t be easy and it could be subject to events outside of our control”.
Threading the needle like this – and with a lagging indicator such as employment as your key benchmark – will require extraordinary timing and lots of luck. And with inflation seemingly already embedded in the minds of consumers in the US (and indeed around the world) it seems more likely that the Fed will have to get the US economy to slow meaningfully to get inflation down to where it wants.
Bank of America’s chief investment strategist, Michael Hartnett, says inflation is so entrenched that the Fed has no choice but to tighten until it breaks either the US economy or the market. Perhaps Powell can avoid that situation, but the risk is still live – and as Hartnett has long predicted, that would be ugly for global markets, which are still historically expensive.
Perhaps the smartest thing for equity investors to do is to heed the words of Macquarie strategist Viktor Shvets. While the markets guru is of the view that the high rates of debt across global financial markets will force central banks to abandon tightening much faster than expected, his broader advice in an address to the Macquarie Australia conference this week was that investors shouldn’t spend too much time worrying about central banks, which increasingly will try to shorten credit cycles to engineer Goldilocks financial conditions that always support asset prices.
“Focus on the basic fundamentals: pricing power, the ability to grow apart from the macro environment, circular drivers, productivity drivers. To me, it’s a much more rational approach than twisting in the wind [with central banks],” he said.