Wealth Strategies

Equities Cheer Fed Chairman's "Dovish" Comments; Wealth Managers React

Tom Burroughes Group Editor August 30, 2021

Equities Cheer Fed Chairman's

Jerome Powell's comments about how the US central bank views inflation risks and the state of the global economy appear to have cheered equity markets. He spoke about an eventual winding down of ultra-loose monetary policy.

The US Federal Reserve’s chairman, Jerome Powell, has restated the central bank’s desire to start moving away from its ultra-loose monetary policy later in 2021. Powell has also given more detail about why he expects a recent sharp rise in inflation to eventually fade.

Still the world’s most powerful central bank, what the Fed says and does helps drive capital and related markets. More than 10 years of quantitative easing since the 2008 financial crash, with a fresh bout of money printing after the COVID-19 pandemic over a year ago, has meant that wealth managers have had to revisit asset allocation models. Listed equities’ yields have been squeezed and government bond yields have been crushed, in some cases turning negative, as is the case in Germany and Japan, for example. 

Speaking in Jackson Hole, Wyoming, on Friday – a regular venue for economic policymakers' discussions – Powell said of the Fed’s late-July meeting: “I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace” of the Fed’s $120 billion in monthly asset purchases this year (source: Wall Street Journal, others). Since that meeting, the economy has seen “more progress in the form of a strong employment report for July, but also the further spread of the Delta variant” of the COVID-19 virus, Powell said. 

Powell’s comments were interpreted by investors that Fed policy will remain loose for some time yet; equities rallied, and US bond yields fell. 

“At Jackson Hole, Fed chair Jay Powell struck a balance that will be seen as slightly dovish, and therefore positive for riskier assets,” Willem Sels, chief investment officer, private banking and wealth management at HSBC, said. 

“He [Powell] repeated that tapering could start this year, in line with the Fed meeting minutes. By preparing for the start of a normalization process, but signaling that such a process would be gradual, both the upside and downside tail risks to bond markets’ inflation expectations are reduced. His signal that interest rate policy will be lagged relative to tapering is also key for bond markets, and allowed Treasury yields and real rates to fall somewhat, while inflation expectations rose mildly after his speech. It is clear that the timing and triggers for tapering are not the same as for rate hikes, which will provide comfort to bond and equity markets,” Sels continued. 

“For equity markets, the gradual process is positive, because it is clear the Fed wants to continue to support the economy for as long as needed to achieve a full recovery. It is therefore no surprise that cyclical sectors reacted most positively to the news,” Sels added. 

Jeremy Lawson, chief economist, Aberdeen Standard Investments, said: “Central banks are unquestionably more transparent than in the past. But Jerome Powell’s speech at Jackson Hole this week was yet more proof that transparency does not mean clarity. And the void that the Fed’s ambiguity leaves comes at a price.”

“Despite the array of Fed officials lining up to say that the time for tapering the QE program is drawing close, Powell continued to keep his options open on the precise timing. Though he acknowledged that in his opinion 'the substantial progress test had been met for inflation,’ he remained more ambiguous about the employment test. The upshot is that we still don’t know with certainty if the taper will begin this year,” Lawson continued. 

“The speech follows a familiar pattern of vagueness from the Fed. The Fed publishes unemployment projections over the short and longer term. But it won’t define maximum employment with Powell recently conceding that: 'it’s very difficult to be precise about it.' With no end point, no one knows when the Fed will reach its destination,” he said. 

The Fed’s inflation objectives are arguably even more mysterious. Last year the Fed shifted to an average inflation target. But they haven’t defined the length of the window over which the average is calculated. They’ve also remained vague about the degree to which inflation will be allowed to undershoot and overshoot the 2 per cent target, admitting that it may be different for every voter. Well, yes, quite. But don’t point people in the direction of something if you’re not willing to tell them what it is,” he continued. 

“Meanwhile, the Fed’s analysis of why inflation has increased so much this year has also lacked substance. Their mantra is that it is mostly due to transitory distortions created by the nature of the pandemic and the reopening of the economy. But what exactly is meant by the term transitory? How can transitory wage and price pressures be distinguished from persistent pressures? And if the acceleration in inflation is due a re-opening they were already expecting, why have their forecasts been so off base? We’re left to guess the answers,” Lawson added. 

Richard Carter, head of fixed interest research at Quilter Cheviot, a UK wealth manager, said: “The very fact that the conference is once again being held virtually due to rising COVID cases in the States is a stark reminder of the impact the virus is still having on our lives. In the US, in particular, the combination of a rise in cases and vaccine hesitancy doesn’t bode well for a recovery in economic confidence.”

“The US is certainly not out of the woods yet, and the numbers instead suggest that we may see some weakening going forward. Indeed, some forecasts have already been revised down. That said, the pandemic-era stimulus cannot go on for ever, and Jerome Powell’s speech was a balanced take on the latest for inflation and what it means for the tapering of monetary support. As one would expect from a central banker, there was nothing dramatic and nothing controversial but the direction of travel is clear,” Carter continued. 

“The Fed is expected to start the tapering process in the last quarter of this year, if not at the start of next year. Investors should take comfort in the fact that this remains some way off, and indeed is only happening because the recovery process has progressed sufficiently. The next couple of Fed meetings will be extremely important,” he concluded.

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