Powell’s Possible Pre-Pivot in 4 Charts

By Giles Coghlan, Chief Currency Analyst, HYCM

Following the Fed’s decision to raise US interest rates by 0.75%, markets are still digesting the contradictory impressions they received from the post-decision press conference.

It was a comparatively dovish address, which is a strange thing to report, considering it followed a 75 basis point hike. But then, the Fed has been “hawkish” in the past without actually doing anything, it has also been “dovish,” purely by virtue of being less hawkish than expected.

And that’s probably what’s going on here. The recent CPI print didn’t elicit a 1% hike from the Fed, so markets interpreted this as the possible early stirrings of a much-anticipated pivot, or at the very least, a sign that the Fed is about to start treading a little more lightly.

Most importantly, it was an address in which he was less willing to commit to the path ahead, effectively removing forward guidance by stating: “We think it’s time to just go to a meeting-by-meeting basis and not provide the kind of clear guidance that we had provided on the way to neutral.”

Notice the word neutral, the Fed believes that a neutral rate is 0.5% above their long-term inflation goal of 2%. A Fed funds rate of 2.25 – 2.50 essentially just got them there. So, now that they’re at neutral, they’ve informed the markets that their policy will be different going forward. This alone accounts for the somewhat confused market response (which we’ll get to in a moment), because markets are sensing that we’re closer to the top in both inflation, and the hiking cycle.

When discussing the health of the US economy, Powell pointed to a softening in recent spending and production indicators, reflecting lower disposable income and tighter financial conditions, weakness in the housing sector partly due to higher mortgage rates, and a decline in business fixed investment in Q2.

Despite this, he believes the labour market remains tight, with unemployment at 50-year lows, job vacancies near historical highs, and wage growth elevated. All of these are reasons why he doesn’t believe the US is in a recession, though he did acknowledge that demand is slowing, which is what the Fed wants in order to bring it back into alignment with supply.

When asked about the market pricing in a pivot in Fed policy early next year, he admitted that inflation had come in higher and economic activity weaker than the Fed expected, and urged people to “take any estimates of what rates will be next year with a grain of salt.”

4 Charts

If you want this shift in Fed stance in chart form, you could do a lot worse than looking at the reactions in the S&P500, the DXY, US 10-year yields, and gold, which all seem to be split 50/50 between risk-on and risk-off.

The rise in the S&P and continued grind lower of the DXY tells the story of a market realising that Powell is now closer to pivoting back to dovish than he is to his previous hawkish turn. In short, back to risk-on. Now, within that frame, we can see that the S&P 500 bulls have currently done a lot more work than the US dollar bears. The S&P 500 has decisively broken a technical downtrend going back to March, whereas the DXY is only just now testing its own medium-term upward trendline as support.

Moving on to 10-year yields and gold, we see the opposite of the above. These charts speak to the uncertainty in markets regarding the future path of inflation, as well as the health of the US economy. In short, risk-off. In this pair of charts, it’s the US 10-year bulls that have done most work, with yields breaking through support and setting lower lows (yields drop as bonds go up). Meanwhile, despite a recent surge in gold prices from the high 1600s to just shy of 1800, gold has yet to break its own medium-term descending trend line from below.

The response by S&P bulls (risk-on) and gold bulls (risk-off) were the same; they bought. Their immediate reasons for buying may have been the same (the Fed pivot is coming), but their respective outlooks couldn’t be more different. You don’t buy gold if you think stocks are going up, and you don’t buy stocks if you think gold is going up. Both, however, share a conviction that a pivot to looser monetary policy is on the cards and the underlying assets of each were hurt by the Fed’s hawkish pivot.

What if we take the S&P 500 and US 10-year yields? These are the two charts whose respective bulls have done the most technical work. Why would stocks and 10-year bonds go up in tandem when yields typically go down when bonds go up? Isn’t the received wisdom that bonds go down and yields go up when stocks go up?

And again, both have gone up despite the fact that you’re not ordinarily buying bonds if you think stocks are going up and you’re not buying stocks if you think bonds are going up.

Could investors be hedging their equities positions by buying bonds? This is definitely a possibility especially when they are still very sensitive to the possibility that this could be a bear market bounce before the downtrend resumes. However, it’s difficult to imagine that very many investors are hedging their stock trades by buying gold.

Uncertain Outlook

The bottom line is that the Fed just greatly increased the level of uncertainty in markets. The removal of forward guidance, the admission of a weaker than expected economy, and the same 75 basis point policy response to a CPI reading that seems to have surprised everyone; all of the above signal that the path ahead is as unclear for the Fed as it is for the rest of us.

This will probably mean increased volatility before a new market theme emerges that investors can understand, which is not what we can see in the charts above. Then, there’s the question of that Powell pivot. Not so much if it will come, but rather whether it will come sooner rather than later. Expect volatility.

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