Powell delivers clear hawkish message at Jackson Hole - Fed is committed to getting inflation back to 2% even if that means some "pain" for the economy. Limited reaction in US rates, but equities tumble

Fed Chair Powell delivered his much-anticipated keynote address at Jackson Hole on Friday night, sending an unambiguous message that that the Fed is committed to getting inflation back to the 2% target.  US rates have been pushing higher in the past few weeks in anticipation of a hawkish message, so there wasn’t much reaction from the rates market.  It was a different story in equity and currency markets though.  The S&P500 crumbled over 3% while the USD was 0.5% stronger on a BBDXY basis, the NZD and AUD particularly hard hit, both down over 1%.  In Europe, the market has moved to price around a 50% chance of a 75bps hike by the ECB next month after reports some members want to discuss such a move.

Powell’s Jackson Hole speech was brief, but on point.  The short speech was almost entirely devoted to the Fed’s commitment to getting inflation back to the 2% target.  Phrases such as “our responsibility for price stability is unconditional”, [the Fed’s] "overarching focus right now is to bring inflation back down to our 2 percent goal”, “we are committed to doing that job”, and “we will keep at it” left no doubt about the Fed’s inflation fighting mantra.  The key message was that the Fed intends keep the cash rate at restrictive levels “for some time ” because history shows that loosening monetary policy too soon can allow high inflation to become entrenched.

There was finally an admission from Powell that some pain would likely be required to get inflation back to 2%, through a softer labour market and slower growth (while a recession was not explicitly mentioned, the implicit message was that a recession might be required).  But the costs would be far greater if inflation expectations were to become unanchored, ultimately requiring a bigger tightening cycle and a deeper recession down the track.  The speech even earned praise from former US Treasury Secretary Larry Summers, who has been vocal in his warnings about inflation since early last year.

Powell didn’t give much away around the rate decision in September, saying it would depend on the data received by that meeting.  However, his firm tone around inflation suggests that the Fed will likely err on the side of doing more rather than less (i.e. another 75bps move), unless the upcoming CPI and payrolls data disappoint.  The market is pricing around a 60% chance of a 75bps hike for the meeting.  Powell repeated the line from the last FOMC meeting that “at some point” it will be appropriate to slow the pace of hikes.

Fed officials had largely foreshadowed the underlying message of the speech in the build up to Jackson Hole, with a whole host of speakers hammering home the message that rates would likely need to be higher for longer to confidently get the job done on inflation. As such, there wasn’t too much reaction from the US rates market to Powell’s speech.  US rates were a few basis points higher at the short end of the curve and as much as 5bps higher at the 5-year point while the 10-year rate was only 2bps higher, at 3.04%.  The market continues to price rate cuts from the Fed from the second half of next year despite Powell’s message that the Fed won’t want to ease policy until it is certain inflation is under control.

Unlike the rates market, the equity market seemingly hadn’t received the hawkish memo ahead of Jackson Hole, so the reaction to Powell’s speech was a big one, the S&P tumbling 3.4% and the NASDAQ off a hefty 4.1%.  The big falls in equity markets on Friday night follow what had been a sizeable rally in July and early August on hopes that inflation might have peaked, and the Fed might soon slow down the pace of rate hikes.  But with Powell suggesting the Fed was prepared to inflict some “pain” on the economy to achieve its inflation objectives, the response in equities was severe.  All sectors of the S&P500 were in the red, with the tech and consumer discretionary sectors hit the hardest (both down around 4%).

The USD was stronger across the board, with the NZD and AUD hardest hit amidst the sharp pullback in risk appetite.  The NZD was 1.4% lower on Friday, ending the week at a six-week low around 0.6340.  The AUD was off 1.2%, closing the week just under the 0.69 mark.  Powell’s speech served as a reminder that a global recession is a real possibility, and both the NZD and AUD have historically tended to perform poorly during major global economic downturns.

The EUR was whipsawed around by a hawkish Reuters report on the ECB and then Powell’s speech, eventually ending little changed, just under parity.  Reuters reported that some ECB members want a 75bps rate hike debated at the upcoming September meeting, with Austrian Governor Holzmann and Dutch Governor Knot, both known hawks, subsequently confirming they were open to the idea.  The German 2-year rate was 11bps higher on Friday night, with the market moving to price around a 50% chance of a 75bps ECB hike in September.  Italian bonds were hammered again, the 10-year rate up 14bps, amidst the hawkish ECB talk and reports that some officials want discussions around ECB quantitative tightening (or ‘QT’) to begin by the end of the year.  Italy was one of the main beneficiaries of the ECB’s huge bond buying programme and would correspondingly be one of the biggest losers were the ECB to consider winding down’s its bloated balance sheet.

There has been no let-up in the hawkish talk from the ECB over the weekend at Jackson Hole, influential board member Schnabel saying “even if we enter a recession, we have basically little choice than to continue our normalization path”.

A deep recession in Europe is looking more inevitable by the day, with European gas and electricity prices continuing to skyrocket.  Dutch natural gas futures were up another 6% on Friday night, to a fresh record high, while German electricity forward prices for a year ahead were up a staggering 25% (they have increased more than three-fold since the start of June).  In the UK, Ofgem, the energy regulator, announced the cap on retail energy bills would increase by 80% from 1 October to the end of the year, after which it is expected to increase even further.

There weren’t any major surprises from Governor Orr’s Bloomberg interview on Friday.  Orr expressed confidence that the RBNZ can get on top of inflation and highlighted that “we think there’ll be least another couple of rate hikes, but then we hope to be in a position where we can be data driven.”  That chimes with his, and other senior officials’, interviews since the MPS, which have suggested the RBNZ’s base case is to get the OCR to 4%/4.25% and then to keep the cash rate at that restrictive level for an extended period.

There was a modest rebound in the ANZ Consumer Confidence Index in August although, at 85.4, it remains at deeply depressed levels and consistent with, at face value, recessionary conditions.  There is a long list of headwinds facing consumers including high inflation, rising mortgage rates, and falling house prices, although the welcome fall in petrol prices over the month provided some immediate relief to confidence levels, albeit relatively small.

NZ rates were little changed on Friday, despite a big fall in Australian rates on the session.  The 2-year swap rate was up marginally, while the 10-year rate was down just 2bps compared to the 10bps fall in Australia.

Today should be relatively quiet, with the UK out for the August Bank Holiday.  But looking ahead, it’s another big week ahead.  Nonfarm payrolls is on Friday night, with the market looking for another strong month of job gains (300k) and a tick down in the pace of average hourly earnings (0.4% m/m expected).  Last month’s payrolls report was a blockbuster, with a net 528k jobs created and much stronger than expected wage growth.  The ISM Manufacturing survey on Thursday night will also be in focus.  The consensus is for a modest fall in the index, to 51.1, but some of the regional Fed surveys (especially the Empire Manufacturing index) warn of the risk of a weaker number.

Post Powell’s appearance at Jackson Hole, there are a host of Fed speakers out this week, the most notable being Vice Chair Brainard, speaking tomorrow morning, and NY Fed President Williams, who is speaking Tuesday night.  In Europe, the key CPI release takes place on Wednesday night, with annual headline inflation expected to remain extremely elevated, at 8.8%, while core inflation is forecast to remain well above the ECB’s 2% inflation target, at 4% y/y.  The inflation report is likely to be influential in steering market expectations towards a 50bps hike or a 75bps move by the ECB next month. The ANZ business survey is the highlight domestically.