A Dovish Powell Could Set Stage for Stocks to Erase All Losses by Year-End

© Reuters.

By Yasin Ebrahim

AiVIF.com -- Federal Reserve chairman Jerome Powell is expected to deliver fresh clues on monetary policy next week, and some investors believe that failure from the Fed chief to push back against bets on a ‘dovish pivot’ could set the stage for a rally in stocks to erase losses by year-end.

“The S&P 500 will move up substantially if and when they [the Fed] signal a pause and sustain a rally that could recover all the losses by the end of the year,” Jimmy Lee, the founder and CEO of The Wealth Consulting Group told AiVIF.com in a recent interview.

The path of inflation holds sway over whether a Fed pause will become reality and potentially help the broader market erase its nearly 12% loss by the end of the year.

Recent reports have pointed to easing in the pace of inflation that is likely to continue, according to Lee.  Spending on services may slow as “the high pricing in travel and leisure industries [ease] after the summer,” Lee says, adding further downside pressure on inflation.

Others, however, aren’t so sure and point to the tight labor market that will boost wage pressures, while other drivers including high rental rates continue to fuel inflation.

“I fear inflation is going to remain hot for a while,” John Luke Tyner, Portfolio Manager at Aptus Capital Advisors told AiVIF.com on Thursday.

“With 5% or 6% wage growth and maybe 6% growth in owners’ equivalent rent as well as the other rental numbers that tack onto CPI, I think it's going to be awfully hard for the Fed to get inflation back down to 2%,” Tyner added.

'Fed Speak' Muddies Rate Hike Debate

The recent messaging from Fed members hasn’t helped clear up expectations on whether the central bank is considering a pivot in policy.

Some members of the Fed appear to be pushing for the central bank to deliver another 75-basis-point rate hike next month, while others are striking a more cautious tone.

St. Louis Fed president James Bullard on Thursday backed the idea of another 75 basis-point rate hike to take the Fed funds rates to a level that will put significant downward pressure on inflation.

Kansas City Fed President Esther George, however, appeared cautious on larger hikes, saying the central bank must be “very mindful” of the lagged impact of its policy decisions on the economy.

The minutes of Fed’s July meeting, released earlier this week, weren’t conclusive and “contained their usual ‘something for everyone,’” National Bank Australia said in a recent research note.

The current odds are slightly skewed toward a 0.75% rate hike at the September meeting, according to AiVIF.com’s Fed rate Monitor Tool. The fed funds rate is expected to peak at 3.67% in March 2023, with about 40 basis point of cuts, thereafter, in 2023. 

Powell to Stick or Twist?

But Powell can reset market expectations on a Fed pivot when he delivers a speech next week at the annual Jackson Hole symposium on Aug. 25-27.

The Fed chief’s remarks will be closely watched for clues on whether the slowing in the economy is starting to dilute the Fed’s resolve to continue front loading rate hikes that some argue are needed to bring down inflation.

Beyond rate hikes, Powell may also turn focus to the Fed’s balance sheet reduction, or quantitative tightening, plan that could be uses as “more of impactful lever to tighten conditions rather than continuing to raise rates at the current velocity,” Tyner added.

If the Fed chief, however, doesn’t push back sufficiently against the growing narrative of a Fed pivot, it risks higher for longer inflation that would spark a surge in long-end Treasury yields and put rate-sensitive sectors of the market such as tech back in the crosshairs.

“If the Fed pivots before inflation is fixed, I think that you see a massive rise in long term bond yields. That's what scares me away from this peak yield narrative,” Tyner said.