Powell’s Inflation-Fighting Speech Sets Up Larger 75bps September Hike

A hawkish speech from the Fed chair focused on the dangers of inflation now has the markets seeing a 75bps hike as the more likely outcome when the Fed next sets rates on September 21. Previously, the markets were leaning towards a 50bps move up in rates, viewing 75bps as possible but less likely scenario based on the CME’s FedWatch Tool which uses market data to forecast expectations for future Fed rate decisions.

The Jackson Hole Speech

Powell’s speech was hawkish. Rather than discuss more esoteric aspects of monetary policy, he chose to deliver what he termed a “shorter” and “direct” message at the Economic Policy Symposium at Jackson Hole on Friday, August 26. He emphasized using the Fed’s “tools forcefully” in a way that will “bring some pain to households and businesses.”

Not A Place To Pause

Also, despite the relatively good news on July’s inflation data, he said that. “A single month’s improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.” He also signaled that the Fed expects to keep going on rate hikes and that neutral interest rates, which are where some may see rates currently, are “not a place to stop or pause.”

Dangers Of Inflation

Powell was looking to make it clear to the markets that the Fed is not done fighting inflation with higher interest rates, and that he views the dangers of inflation to the U.S. economy as highly significant. He referred to lessons from history, where Fed sluggishness in raising rates or stopping too early caused greater economic pain.

The only mildly positive point was that Powell stated. “At some point, as the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases.” However, those looking for an optimistic note in Powell’s speech, won’t find much to go on.

Longer-Term Impact

The market has interpreted Powell’s comments as implying that September will likely see a higher move up in rates, but that beyond that the trajectory for rates will be broadly similar to before, with perhaps a 25bps-50bps move in November and maybe a 25bps hike in December with some chance of holding rates steady. So rates may continue to rise, but the will pace slow in the market’s view.

The markets believe that Powell is serious about a big hike in September similar to the most recent meetings. Yet they still doubt that the Fed will continue to hike rates much beyond the end of 2022.

The markets see rates hitting 4% at the December meeting, but after that, the markets see rates either holding steady or falling. There’s only a 1 in 5 chance of a rate hike at the first meeting of 2023 on current estimates.

Two Scenarios

This may be because the market is more optimistic on inflation than the Fed. Maybe the market believes that following the July data, we will see inflation falling faster than the Fed currently anticipates over the coming months. If true that would be good news for both the Fed and the economy.

However, the darker scenario is that the markets see a recession coming. Powell’s speech signaled that the Fed was ready to take some economic pain to fight inflation, but maybe the markets doubt that resolve, and question if the Fed will hike rates through a recession. That scenario may also mean bad news for the housing market.

A 75bps Move

So Powell definitely took advantage of his recent speech to make clear the priority he places on fighting inflation. The markets interpreted that as a shift in priority from a 50bps to a 75bps hike on September 21.

However, beyond that the markets have either more confidence than Powell that the Fed’s job will be done, or worry about a looming recession and the Fed’s commitment to raise rates during a time of economic pain. Powell may have shown conviction to fight inflation in his speech, but the markets remain uncertain as to the path of interest rates next year.

Even despite expectations for a September hike moving up, there appears to be a disconnect between Powell’s speech and market expectations. That may not end well for markets in the short term if the Fed keeps its nerve.