The world held its breath yesterday as Fed Chair Powell spoke about inflation and interest 
rates.
When all was done, stocks and bonds loved what they heard. Both rocketed higher.
We believe that this knee-jerk ecstasy was misguided.
We take a more measured approach as we continue to position our clients for capital preservation in these increasingly uncertain times.
In short, Powell confirmed that interest rates will remain higher for longer.
1. Inflation is still too high.
2. Interest rates will continue to go up.
3. Interest rates will remain high for the foreseeable future.
4. When interest rate increases are slowed or paused, it will not mean they’ll be lowered.
The rally in stocks and bonds confirmed that Wall Street still doesn’t believe Powell. The Street believes that he will succumb to their whining … or political pressure.
Here we deconstruct Powell’s speech with his direct quotes.
“… inflation remains far too high …”
“It will take substantially more evidence … that inflation is actually declining.”
“By any standard, inflation remains much too high.”
This is Powell’s second emphasis that inflation remains “too high”.
“… we think we need to see to bring inflation down to 2 percent over time.”
This means that interest rates will have to drop 4% -5% from current levels. That is an enormous decline from where we now are.
“… we need to raise interest rates to a level that is sufficiently restrictive to return inflation to 2 percent. There is considerable uncertainty about what rate will be sufficient …”
Again, Powell mentions 2% as an inflation target. Down a whopping 400-500 basis points from current levels.
“It seems to me likely that the ultimate level of rates will need to be somewhat higher than thought at the time of the September …”
This is a second mention that interest rates must continue to be raised.
“We are tightening the stance of policy in order to slow growth in aggregate demand.”
This is present tense “We are tightening … “ another indication that higher rates are on the way.
“… demand growth has slowed, and we expect that this growth will need to remain at a slower pace for a sustained period.”
Powell is again telling us that interest rates will remain high into the foreseeable future.
“Despite the tighter policy and slower growth over the past year, we have not seen clear progress on slowing inflation.”
Powell is again telling us that higher rates have not yet done their job and so, again, interest rates will remain high into the foreseeable future.
“Despite some promising developments, we have a long way to go in restoring price stability.” (e.g. inflation).
At the risk of my sounding repetitive, Powell is again telling us that higher rates have not yet done their job and so, again, interest rates will remain high into the foreseeable future.
Then Powell mentions, in this next line, that the December interest rate hike may be less than the ¾% (75 bps) that has been expected. Wall Street took this as wildly positive news and markets rocketed higher.
“Thus, it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting.”
Then Powell addresses the elephant in the room (how much higher will interest rates go), saying that the size of each hike is less important than how high they must go to control inflation:
“ … the timing … is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level.”
This is another declaration that rates will remain higher into the foreseeable future.
“ It is likely that restoring price stability will require holding policy at a restrictive level for some time.”
Words matter.
Powell continues to speak in terms of interest rates being held at a “restrictive level.” A declaration that rates will remain higher into the foreseeable future.
Powell finishes his speech with a Paul Volcker like flourish that tells us his mindset.
“We will stay the course until the job is done.”
As we noted at the beginning of this piece, we see Powell confirming the following 2 investment themes:
1. Interest rates will remain high for the foreseeable future.
2. When interest rate increases are slowed or paused, it will not mean they’ll be lowered.
This means more pain for interest rate sensitive assets such as stocks, bonds and real estate.
Contact us if we can help you navigate these troubled waters.
The information contained in this Higgins Capital communication is provided for information purposes and is not a solicitation or offer to buy or sell any securities or related financial instruments in any jurisdiction. Past performance does not guarantee future results.
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Ray Higgins
San Diego