(Bloomberg) — The most decisive signal yet from Jerome Powell that his inflation-fighting mission has been accomplished has helped restore order to markets that just three weeks ago were engulfed in the worst turmoil since the pandemic.
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Today, the return to calm is creating new wealth on Wall Street and bolstering the Federal Reserve chairman’s efforts to preserve his legacy and avoid a coming economic downturn.
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Less than a month after a weak jobs report sent volatility indices soaring, stock markets are once again at peace. The S&P 500 climbed to within 1% of an all-time high Friday, nearly erasing a tumultuous slide that began in mid-July. Exchange-traded funds that track Treasuries and corporate bonds have soared this week. The VIX index, Wall Street’s gauge of fear, has settled comfortably below levels that indicate panic.
The market backdrop is a boon for Powell, who used his speech in Jackson Hole, Wyoming, on Friday to say that Fed policymakers “will do everything they can to support a strong labor market” as inflation eases.
In other words, belying the warnings of slowing economic growth in the interest rate market and the asset meltdown of early August, Wall Street and Jerome Powell are now on the same page in promoting a soft landing.
“With the Fed shifting to a more dovish stance, emphasizing stimulus rather than restraint, the rise in risk assets has become a positive for Fed policy rather than a negative,” said Seema Shah, chief global strategist at Principal Asset Management. “Working almost like an automatic stabilizer, markets should make it easier for the Fed going forward.”
With inflation trending toward 2%, Powell’s speech marked his most explicit shift yet, moving away from the campaign to restore price stability to focus on supporting the economy, particularly the labor market. Aspects of his speech were interpreted by Wall Street as evidence that the Fed is not ruling out cutting interest rates by more than 25 basis points at one of its final three meetings this year.
The U.S. labor market has cooled significantly and policymakers “will do everything they can” to support it, he said, adding: “The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of further undesirable weakening in labor market conditions.”
Ultimately, after facing a barrage of criticism in the era of inflation, Powell is once again proving himself a friend to risky asset traders.
“I’m not here to praise Powell, but I think he’s been very wise to leave room for action,” said Steve Chiavarone, senior portfolio manager and head of multi-asset management at Federated Hermes. If nonfarm payrolls were to rise by less than 100,000 in August, “then it would have to be 50 basis points,” he said.
Expectations of a change in monetary policy helped propel Bloomberg’s benchmark 60/40 model to a record high, posting gains in seven of the past eight months on its way to a 12% year-to-date gain. Small-cap stocks are on the rise again, adding 6.5% in two weeks. While holding above the lows of May and July, bond market volatility has eased.
While a new bout of turbulence could easily be triggered, especially two weeks before the release of key employment data, for now, price movements are fueling Powell’s plans. While the decline in bond yields can be seen as a sign of economic concern, their decline has also coincided with a roughly 1.3 percentage point reduction in mortgage rates since October, a potential antidote to the housing freeze. Credit spreads remain tighter than at any time since the financial crisis, which is spurring a pickup in corporate borrowing.
All of that has pushed the Chicago Fed’s financial conditions index to its loosest levels in more than two years. A similar measure from Goldman Sachs Group Inc. is the least restrictive since 2022.
“The easing of financial conditions should support businesses and consumers, who should be able to borrow money more cheaply and feel wealthier thanks to higher stock prices,” said Chris Zaccarelli of Independent Advisor Alliance. At the margin, it “could support consumer spending and corporate profits and prevent future layoffs,” he said.
Of course, any sign that the labor market is struggling would likely end the market’s celebration. Payroll revisions released Wednesday reinforced the Fed’s assessment that hiring has been weaker than expected. Estimates of the unemployment rate are at their highest level since November, while the probability of a recession in the next 12 months rose for the first time since March 2023, according to Bloomberg’s latest monthly survey of economists. Still, the odds of an economic contraction are now less than half what they were last year.
History is replete with examples of markets and central banks that were lulled by the promise of a soft landing only to see their economies falter a few months later. Rising stocks and bonds failed to prevent the recessions of 2000 and 2008. Yet while the role of financial conditions in the economy is tenuous, the recent easing — thanks to the surge in stocks — should support a sagging economy this year, analysts say.
“While the funds rate is still elevated, our overall financial conditions index is not particularly tight and has even eased slightly over the past year,” said David Mericle, Goldman Sachs’ chief U.S. economist. “The model we use to estimate the impact of changes in financial conditions on real economic activity implies that this easing in financial conditions provides a modest boost, of about ¼ percentage point, to GDP growth in 2024.”
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