Stocks took off on a moon shot higher on the day after US Federal Reserve Chairman Powell said the Fed may reduce future interest rate increases to 50-point increments as soon as this next meeting.
The Federal Reserve Chairman took pains to highlight that this was not his key message, but the market certainly thought it was.
After a day that was again seeing fresh losses on Wall Street, stocks catapulted higher in one of the most spectacular intra-day rallies ever seen. Fast and consistent to the upside, as news headlines blared the Fed would be slowing.
All kinds of momentum trading programs kicked in, while the funds management industry salivated that markets can only go up anyway?
Chairman Powell, however, sought to highlight that this was in no way the end of the Fed’s tightening cycle. That a more clear-cut slowing in the economy and weakening of the employment outlook was required to even begin to move inflation sustainably back toward 2%.
The Chairman went to lengths to highlight that interest rates would still be going significantly higher and would stay high for a considerable time.
We already knew this would happen, but some of the mainstream media managed to make it sound like this was some kind of shocking news. Everyone was being forced and or encouraged to buy on the day. Hence a monumental rally.
Can it last?
Two very clear macro forces will now battle to decide the answer to this question. One is related to the real-world economic impact, and the other to the financial markets themselves.
There can be no doubt, as Powell said so in his remarks today, that rates will continue to go up at a historic pace and the economy will be further crushed. Powell said that inflation while moderating for goods, will be rising for housing and services generally in the year ahead. That the inflation battle will intensify further. That rates will end up being much higher and for longer than it would seem the market generally understands.
We should therefore expect an even more intense economic slow-down and considerable mortgage stress leading to falls in property values over the coming year.
The economic outlook actually just worsened on Powell’s comments, but the market wanted to be simplistic and merely celebrate that rates would continue to rise at 50 points, instead of 75 points. Not a valid reason for celebration, but the market took it that way. It is as if we live in a headline-only driven world.
The other major force that is immediately, and will increasingly be at play, is that the entire funds management industry will be spinning this as hard as they can as the signal for everyone to reinvest in the stock market. They will be buying aggressively and telling their clients to panic invest again. This is a considerable force. There are now large cash holdings still washing around the world from all the free money of recent years.
What we are left with, is the risk that the stock market rallies as the economy crashes under the weight of continued higher rates. This is a calamitous scenario.
The view here is that the real-world economic impact of continued rate hikes by the Federal Reserve will be dire. Stocks will in the end crash yet again.
For how long this new rally will last however is difficult to gauge. It may be a snowflake melting in summer affair, or could even persist for a few weeks.
At the moment, the narrative shifts back to rates still going higher and the economy is in even more trouble, the objective reality, then we will very quickly see stocks fall away and rather badly at that.
Stocks can go a bit higher in the immediate term, but all of this means the US economy will be crushed by a sustained aggressive interest rate policy from the Federal Reserve.
Market insights and analysis from Clifford Bennett, Chief Economist at ACY Securities
