Jerome Powell’s Pivot Fuels an All-Conquering Wall Street Rally

Denitsa Tsekova and Isabelle Lee
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(Bloomberg) -- Jerome Powell’s most decisive signal yet that his inflation-fighting mission has been accomplished has helped restore order to markets that only three weeks ago were engulfed in the worst upheaval since the pandemic.

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Now the return to calm is creating new riches on Wall Street — and boosting the Federal Reserve chair’s legacy-securing bid to avert an economic downturn ahead.

Less than a month after a sketchy jobs report sent indexes of volatility soaring, peace reigns again across assets. The S&P 500 climbed within 1% of an all-time high Friday, all but erasing the tumultuous drop that began around mid-July. Exchange-traded funds tracking Treasuries and corporate bonds shot up this week. The VIX index, Wall Street’s fear gauge, has settled comfortably below levels denoting panic.

The market backdrop is a blessing for Powell, who used his address at Jackson Hole, Wyoming, Friday to say Fed policy makers “will do everything we can to support a strong labor market” as inflation subsides.

Put another way, belying warnings of slowing economic growth in the interest-rate market and the early-August cross-asset swoon, Wall Street and Jerome Powell now find themselves on the same page in promoting a soft landing.

“With the Fed shifting to a more dovish stance, focusing on stimulus rather than restraint, the risk asset rally has become a tailwind for Fed policy rather than a headwind,” said Seema Shah, chief global strategist at Principal Asset Management. “Working almost like an automatic stabilizer, markets should make the Fed’s job that much easier now.”

With inflation trending toward 2%, Powell’s address marked his most explicit shift yet away from the campaign to restore price stability and toward bolstering the economy, especially the labor market. Aspects of his speech were interpreted by Wall Street as evidence the Fed doesn’t rule out cutting interest rates by more than 25 basis points at one of its three remaining meetings this year.

The US labor market has cooled considerably and policy makers will “do everything we 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 unwelcome further weakening in labor market conditions.”

The upshot is, after facing a flood of criticism in the inflation era, Powell is proving a friend once again to traders across risky assets.

“I’m not in the business of praising Powell but I thought he was quite wise in leaving optionality open,” said Steve Chiavarone, senior portfolio manager and head of multi-asset at Federated Hermes. Should non-farm payrolls rise by less than 100,000 in August, “then it better be 50 basis points,” he said.

Expectations of a dovish policy pivot have helped push Bloomberg’s benchmark for the 60/40 model to a record high, scoring gains in seven of the past eight months en route to a 12% year-to-date gain. Small-cap stocks are again ascendant, adding 6.5% over two weeks. While holding above the lows of May and July, bond market volatility has eased.

While another episode of turbulence could easily ignite, especially with key readings on payrolls two weeks away, for now the price moves are feeding into Powell’s plans. While falling bond yields can be framed as a sign of economic disquiet, their descent has also coincided with about a 1.3-percentage-point reduction in mortgage rates since October, a potential antidote to the frozen housing market. Credit spreads remain tighter than any time since before the financial crisis, spurring a pick-up in corporate borrowing.

All that has pushed an index of financial conditions kept by the Chicago Fed to the loosest levels in more than two years. A similar Goldman Sachs Group Inc. measure is the least restrictive since 2022.

“The loosening of financial conditions should be supportive of corporations and consumers, who should be able to borrow money more cheaply and feel wealthier from higher stock prices,” said Chris Zaccarelli at Independent Advisor Alliance. At the margin it “could support consumer spending and corporate profits and forestall future layoffs,” he said.

Of course, any sign the labor market is in serious trouble would likely put an end to the market’s celebration. Payroll revisions released Wednesday reinforced the Fed’s assessment that hiring has been weaker than thought. Unemployment-rate estimates sit at 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 the latest Bloomberg monthly survey of economists. Still, the odds of an economic contraction are now less than half of last year’s level.

History is full of instances of markets and central banks alike being lulled into the promise of a soft landing only for economic weakness to emerge months later. Rallying stocks and bonds did nothing head off recessions in the run-up to 2000 and 2008. Still, while the role of financial conditions in the economy is tenuous, the loosening of late — thanks to spirited equity rally — should lend support to a weakening economy this year, the thinking goes.

“Although the funds rate is still high, our overall financial conditions index is not particularly tight and has actually eased a fair bit over the last year,” said David Mericle, the chief US economist at Goldman Sachs. “The model we use to estimate the impact of changes in financial conditions on real economic activity implies that this easing in financial conditions is providing a modest, roughly ?pp boost to GDP growth in 2024.”

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