The More Powell Spoke, the More Stock and Bond Markets Rallied

(Bloomberg) — Behind closed doors, Federal Reserve policy makers worry rallying markets are impeding their efforts to control inflation. But every time Jerome Powell goes out in public he gives them more room to run.

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When the Fed chairman took to the podium Wednesday afternoon, stock markets were hovering around their session lows. The central bank had just delivered an eighth straight rate hike and signaled more were to come, and some of the uber-bullishness on display in markets this year had faded a little.

By the time Powell was done speaking some 45 minutes later, stocks had soared. The S&P 500 reached its intraday high, up 1.8%, and traders were also quickly bidding up prices on Treasuries, corporate bonds and crypto.

Powell may have intended to deliver a stern message that the Fed still had a lot of work to do to tame inflation but that’s not what investors heard. Instead, they heard a chairman who indicated he was seeing clear evidence of slowing consumer price increases and who didn’t seem particularly bothered by the January rally in markets.

For the second straight meeting, the very first question he was asked at the press conference was whether he was worried about the rally creating easier financial conditions that could hamper his inflation fight and, once again, he chose not to push back hard. “Our focus is not on short-term moves, but on sustained changes” to financial conditions, he said.

“There’s a real disconnect between what he said, what the statement said, maybe what he wanted to say, and what the markets heard,” BlackRock’s Jeffrey Rosenberg said on Bloomberg TV. “But what the markets heard was this issue of the conflict between financial conditions easing, and whether or not that would impact the Fed’s policy making — he dismissed it.”

Powell’s response came on a day that was not without tough talk on inflation, with the chairman repeatedly stressing that while price pressures in the economy had eased, the battle was far from won. Policy makers lifted the Fed’s target for its benchmark rate by a quarter percentage point to a range of 4.5% to 4.75% and said ongoing increases will be appropriate, a signal to most that no pause in tightening is imminent.

But investors had been bracing for harsh commentary from the Fed aimed at cooling the recent run-up in risk assets. The chairman instead argued that readings have tightened “very significantly” over the past year as the Fed hiked.

The emphasis on tighter conditions is being taken by traders as evidence the latest rallies in equities and credit are not a major concern for policy makers, essentially freeing them to bid up prices. Some analysts question what measure Powell was referring to — a Bloomberg index of US conditions across markets sits today at a looser level than it was when the Fed began its tightening campaign last year.

“Powell has said that financial conditions have tightened considerably despite the fact that they have eased considerably,” wrote Neil Dutta, head of US economic research at Renaissance Macro Research LLC. “The fact that he has said this is dovish in its own right,” according to Dutta, who added: “the odds are increasing that the Fed is declaring victory too soon.”

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Wednesday’s stock rally is a continuation of what’s been happening all year in markets, with stocks surging and volatility easing versus last year. The S&P 500 last month gained more than 6% in what was its best showing since October. The Cboe Volatility Index, a gauge of cost of equity options, fell to the lowest level since the immediate aftermath the S&P 500’s last all-time high reached in January 2022.

Traders who had braced for a hawkish Fed were caught off guard and rushed to short-term options to play catch-up. Contracts within 24 hours to expiry accounted for almost 40% of all S&P 500’s total volume, with trading in bullish calls outpacing bearish puts.

The expression of optimism was even more evident in the interest-rate swaps market, where traders are now pricing a half percentage point rate cut in the second half of the year after rates peak near 4.9%.

None of the market action is likely what the central bank wants to see as it looks to continue to rein in inflation, said Adam Phillips, managing director of portfolio strategy at EP Wealth Advisors.

“I’m surprised Chairman Powell didn’t use this opportunity to deliver a wakeup call to those investors who seem to have gotten ahead of themselves,” he said. “There are ways to acknowledge the progress that’s been made on inflation while still talking tough on the work that needs to be done.”

–With assistance from Isabelle Lee.