What Does Chair Powell’s Testimony Mean for the Markets?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jul 18, 2018 2:45:22 PM

and tagged In the News

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chair powellWe are nearing the end of the regular semiannual testimony by the chair of the Fed, Jerome Powell, in front of Congress. Yesterday, he spoke to the Senate and today he is speaking to the House. As the most influential economic official in the world, what Powell says carries real weight.

So, what does Chair Powell’s testimony mean for the markets? There are three key points that I think investors should pay attention to.

1) Powell is bullish on the economy

In his prepared testimony, and in line with the minutes from the past Fed meeting, Powell essentially repeated his declaration of victory over unemployment and inflation. The labor market is “robust” and has continued to improve, economic growth is “solid,” and the second quarter was “considerably stronger” than the first. Further, inflation data is “encouraging.” Best of all, the Fed expects that “the job market will remain strong, and inflation will stay near 2 percent over the next several years.”

2) The current rate policy is on track

Because of that positive view on the economy, the Fed thinks “the best way forward is to keep gradually raising the fed funds rate”—steering between the risks of raising too fast and those of raising too slow. In other words, the current policy is on track, and the Fed sees nothing to worry about.

Great news for the markets. From a market perspective, this is great news. First, the Fed continues to endorse the recovery. Second, while the Fed will keep raising rates, it will do so gradually and for the right reasons. When the Fed raises rates to fight inflation, that is bad because it tends to do so faster in order to choke that inflation off. But when the Fed raises rates to moderate continuing growth (which is what Powell is saying it will do), that is good; it allows growth to keep going. What Powell just told the markets is that he expects the Goldilocks economy to keep going for the foreseeable future.

Small wonder market reaction has been positive, even in the face of other, more political concerns. In fact, U.S. markets were up yesterday and so far today, after a couple of (probably) political down days. What really matters for the market, at least at the moment, is the economy. Powell just blew the all clear.

What Powell didn't say. Just as important, though, is what Powell didn’t say about the economy. Note that in the prepared statement, Powell had quite a bit to say about the things that are going right: stimulative interest rates, a stronger financial system, lower taxes and rising government spending, and faster growth abroad. Risks, however, were given short shrift. The risks of the rising trade conflict were dismissed with the following: “it is difficult to predict the ultimate outcome of current discussions over trade policy.” I would argue the trade issue merits a bit more discussion than that.

In fact, when you get to the final conclusion—that “we see the risk of the economy unexpectedly weakening as roughly balanced with the possibility of the economy growing faster than we currently anticipate”—it is hard to see why. After hundreds of words about opportunities and about 20 on risks, I get the sense that the Fed really doesn’t believe in the risks and does believe it has this nailed. That is, the risks are under control. Remain calm, all is well.

3) The Fed may be overly confident

This brings us to the third takeaway from this testimony. Confidence at this level rarely ends well. I want a happy Fed, and I want a confident Fed. We clearly have that. The question I have is whether this Fed is now too happy and confident.

This statement omits most of the cautionary notes and caveats we have gotten accustomed to under the Yellen Fed. Conditions are better, I get that, and the statement has to reflect that. Immediate market reactions are positive. But have the risks really disappeared?

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