Bottom line: the Powell Jackson Hole speech reinforces my belief that the Federal Reserve is about to begin the long process of normalizing monetary policy, which means a gradual shift away from the near zero rates begun in March 2020. Rates will eventually rise which warrants a shift to more defensive bond portfolio position with shorter maturities. The writing is on the wall. I do not see this policy shift as a threat to further gains in the stock market, however, and I expect equities will continue to outperform bonds over time.
The Chairman of the Federal Reserve Board typically delivers a major policy address at the annual economic policy symposium sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming; typically referred to as the Jackson Hole speech. The speech is a highly visible opportunity for the Fed Chairman to communicate key aspects and thoughts surrounding current and future Federal Reserve monetary policy.
First, let me say I am a fan of Jay Powell. I like his style and his approach to communication on topics that can be convoluted and confusing. I also like that he quietly acknowledges the limits of Fed policy and macroeconomic analysis and forecasting: a forecast is just that and not a guarantee.
Second, while I consider the speech important, I expect these comments to be less short-term and tactical in nature and more oriented to the longer-term outlook and highlight major factors influencing future decisions. As an analyst, the address helps me interpret upcoming data, comments, and decisions and put them in perspective. Powell stuck to his “knitting” in the speech and appeared to deliberately avoid direct comments on current or prospective fiscal programs. He was only concerned with how the evolving economic landscape affects the Fed’s dual mandate of maximum employment and low inflation.
So, with that said, I believe Powell’s talk provided an important perspective on where the pandemic-stricken economy has been and where we are likely headed given the plethora of risks and uncertainties. His remarks suggest the economy has progressed far enough and fast enough for the Fed to begin the long gradual process of unwinding the exceptionally accommodative policy initiated at the beginning of the pandemic, barring further unexpected events.
Total employment is still below the pre-pandemic peak and the unemployment rate is roughly two percentage points above the low, but incoming data suggests rapid improvement. Rapid and sustained growth has been a critical metric for any shift in policy at the Fed. Powell discussed the all-important topic of inflation in some detail and how the Fed monitors developments in this area. He expects the recent pop in inflation to be transitory and not warrant an immediate or aggressive reaction from the central bank. He explained his position in an organized and logical manner. Powell contends the details within the inflation reports, combined with continued low inflation expectations, suggests inflation is not racing out of control, and that the Fed is taking the right steps and communicating effectively with the market.
On balance, Powell stated the economy has improved far enough and fast enough to start reducing or “tapering” the monthly amount of bonds purchased by the Fed prior to yearend. This move will be the first step in what will likely be a long process of normalizing monetary policy. If your recall, the Fed first lowered short-term rates to near zero at the beginning of the crisis, and then they provided additional stimulus to the economy and the functioning of the bond markets by directly purchasing Treasury and mortgage bonds every month. Tapering of these purchases is the first step in unwinding the exceptional monetary stimulus. Powell was clear that it would be some time before the Fed raises interest rates, though he wisely offered no date for any eventual rate hikes. While I don’t believe investors need to rush out and immediately sell all their fixed-income securities, I believe the writing is on the wall. Higher rates are coming, and higher rates lower bond values.
Equally important, in my view, is that the Fed will not act in haste and take any actions that threaten the health of the economy and the life of the current expansion. This approach is a powerful and positive message for stocks, in my opinion. Interest rates historically trend higher during expansions without sending equities into a tailspin. It is only if Fed policy turns aggressive and short rates rise above long rates that the economy and stock market are in trouble. As a result, I continue to favor stocks over bonds in balanced portfolios, but I will keep my eyes open for any adverse changes in the economy or policy that might slow future growth.