What Direction Will Powell Go?

Jerome Powell released his first statement and testimony as Fed Chairman at 8:30 AM on the 27th of February. The market was expecting Powell to be potentially more dovish than Yellen and to give a market neutral statement. His initial statement suggested that he would be going along the same tightening path as his predecessor, Janet Yellen with further gradual rate hikes.

However, in his testimony at 10 am, he mentioned that the Fed would re-evaluate their current expectations of three rate hikes in 2018 due to strong economic data and incoming tax cuts. This was a hawkish statement implying we could see four rate hikes in 2018 thus causing a huge selloff in Treasury bonds and the equity markets. The Dow Jones Industrial Average fell by 400 points, gold prices fell by $13 and 10- year Treasury yields spiked up to around 2.9% after Powell’s comment. Bonds were already entering a bear market due to rising yields despite the recent rally on Friday. Yet, this hawkishness from Powell will potentially cause a further collapse in the bond market and is almost guaranteed to make 10- year Treasury yields to at least break above the 3% level.

Trump appointed Powell as new Fed Chair in hopes that he would be a more dovish chairman than Yellen, especially since it’s in the Trump administration’s interest to sustain strength in the equity market. On the other hand, it appears that Powell may lead a more hawkish path for the Federal Reserve, which would cause some drag on stock indices and lead to higher market volatility.

Powell stated that the Fed is expecting inflation to creep up to their 2% goal during the year due to higher CPI numbers in February, which would potentially justify further hikes. In addition to this, the Fed has been eager to hike rates since for the last decade we have been in a historically low-interest rate environment. We have been long overdue for a huge correction and keeping these low rates will make it difficult for the Fed to implement expansionary policies through interest rate cuts when the time comes. Moreover, entering another round of QE in the event of a recession could possibly lead to dangerously high levels of inflation.

Whether Powell intended to signal to the market that we could see further tightening in 2018 or not is something we will have to monitor, especially since the previous Fed chairs have all made mistakes in accidentally giving the market wrong signals in their first testimony as chair.

UPDATE: Powell made his second testimony to the Senate on March 1, 2018. He didn’t seem to appear to retract any of his hawkish comments on Tuesday except mentioning that he doesn’t see such strong wage growth (nothing significant). The Dow Jones Industrial Average and gold prices continued to selloff. On the other hand, US 10- year Treasury yields retraced to around 2.84%. On an interesting note, Powell stated that ‘we aren’t on a sustainable fiscal path’, probably referring to Trumps tax cuts and infrastructure spending. It appears Powell is continuing his hawkish sentiment and perhaps giving Trump the middle finger.

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