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

(Bloomberg) — Behind closed doors, Federal Reserve policymakers worry that markets are rallying 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 the podium on Wednesday afternoon, the stock markets were throwing around their session lows. The central bank had just delivered an eighth straight rate hike and signaled more to come, and some of the uber-bullishness shown in the markets this year has faded somewhat.

When Powell spoke some 45 minutes later, stocks soared. The S&P 500 hit its intraday high, up 1.8%, and traders also quickly paid prices on Treasuries, corporate bonds and crypto.

Powell may have intended to deliver a stern message that the Fed still has a lot of work to do to tame inflation, but that’s not what investors heard. Instead, they heard a president who indicated that he sees clear evidence of the extension of consumer price increases and who does not seem particularly bothered by the January rally in the 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 hinder his inflation fight, and again, he chose not to hard to push back. “Our focus is not on short-term moves, but on sustainable changes” in financial conditions, he said.

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“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 the easing of financial conditions, and whether or not that affects the policy of the Fed – he dismissed it.”

Powell’s response came on a day that was not without tough talk about inflation, with the president repeatedly stressing that while price pressures had eased in the economy, the battle was far from won. Policymakers 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 were appropriate, a signal to most that no break in the tightening is imminent.

But investors braced for tough comments from the Fed to cool the recent run-up of risk assets. The president instead argued that readings have tightened “very significantly” over the past year as the Fed has stepped up.

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The emphasis on tighter terms is taken by traders as evidence that the recent rallies in stocks and credit are not a big concern for policymakers, essentially freeing them to bid up prices. Some analysts are wondering what measure Powell is referring to – a Bloomberg index of US market conditions today sits at a looser level than it was when the Fed’s tightening campaign began last year.

“Powell said that financial conditions have tightened significantly 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 said this is dovish in itself,” according to Dutta, who added: “the chances are increasing that the Fed will declare victory too soon.”

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Wednesday’s stock rally is a continuation of what has been happening in the markets all year, with stocks rising 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 measure of the cost of stock options, fell to its lowest level since the immediate aftermath of the S&P 500’s last all-time high reached in January 2022.

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Traders who had braced for a hawkish Fed were caught off guard and rushed to short-term options to catch up. Contracts within 24 hours to expiration accounted for nearly 40% of the 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 cutting rates by half a percentage point in the second half of the year after peaking at 4.9%.

None of the market actions are likely to be what the central bank wants to see as it looks to further curb inflation, said Adam Phillips, managing director of portfolio strategy at EP Wealth Advisors.

“I’m surprised that Chairman Powell didn’t use this opportunity to deliver a wake-up call to those investors who seemed to be getting ahead,” he said. “There are ways to acknowledge the progress that has been made on inflation while still talking loudly about the work that needs to be done.”

–With help from Isabelle Lee.

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