August 27, 2022

FED resolution to fight inflation: The short and medium term 

A)The expectation of FED chairman Powell speech at Jackson Hole was that it would provide a determination to fight Inflation at the expense of employment and growth.

B) The reaction to the speech was obviously a short term disappointment.

The market participants interpreted that the FED is more hawkish than anticipated.

As the trading day progressed and the messages of the speech digested the indices kept falling.

C) The two year Treasuries appreciated by about 20bp to 3.38pct. Interestingly the preferred inflation statistic, PCE, dropped to 6.3 pct in July (from 6.8 pct in June) and the 10y bonds stayed at 3.03 pct. Inflationary expectations are key in this battle.

D)The implication is that FED funds rates will increase to the area of 3.50 to 4.00 pct by  Q1 2023 to fight inflation. They are now expected to stay high for some time and not reverse course.

The aim is to get inflation back to 2.00 pct. Inflationary expectations have to be slashed and incoming data have to show continuous improvements before a radical change in contractionary  monetary policy takes place. 

Ε) Employment and growth are considered now as issues of secondary importance. Hopefully the inflation reduction effort will be achieved with a slowdown or a mild recession and not at the expense of a serious recession.Expectations and reactions of consumers and investors in the expected slowdown will be pivotal. No help from fiscal policy on growth is expected as monetary policy will continue to be restrictive.

F) However, the stance of the FED might eventually be interpreted positively by the market. Participants might realize that the FED  policy becomes credible and inflation will be slashed . Evidently if we get new data with positive pleasant surprises will help markets : inflation statistics, supply chain news linked to Ukraine and to the Covid disruptions from China.

Conclusion : we have negative interpretations of the speech short term. 

Hopefully positive views might emerge medium term !

Would be cautious with the market but not a seller.

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