Powell Won’t Throw in the Towel: More Rate Hikes Are Coming

It’s late bull market behavior at its finest. At the annual Jackson Hole symposium, Federal Reserve Chairman Jerome Powell unequivocally declared that the central bank is “prepared to raise rates further” in its quest to bring inflation down to 2%.

In addition, Powell warned that the Fed intends to “hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.” That should have been enough to send stock prices lower, right?

As always, we must expect the unexpected in the financial markets. The major stock market indexes actually moved higher after Powell’s speech, despite clear indications that the Fed is prepared to tighten the screws on the economy in the coming months.

To help make sense of this, first it must be understood that the market doesn’t believe the Fed. The central bank makes policy decisions on the fly, and it’s not unusual for the Federal Reserve to flip from hawkish to dovish or vice versa.

Also, it appears that eager stock traders focused their attention on Powell’s statement that, after a prolonged series of interest rate raises, the Fed is “in a position to proceed carefully” as it considers its future actions. Thus, the market interpreted this to mean that the central bank might not hike the federal funds rate at the next FOMC meeting.

Courtesy: @KobeissiLetter

Moreover, people know that the government can’t afford high interest rates for too much longer. The interest expense on the nation’s federal debt currently stands at 19.5% of U.S. government revenue, which is a record. Since this is unsustainable, “higher for longer” interest rate policy can’t be maintained indefinitely.

Besides, there wasn’t really any new information imparted by Powell’s Jackson Hole speech this year. Compared to last year’s Jackson Hole speech, Powell acknowledged that “the message is the same” at this year’s address.

Nevertheless, the futures market is currently pricing in a 25% interest rate raise in November. Hardly anyone really expects the Fed to start cutting interest rates anytime soon. That fantasy has evaporated, thanks to the tough talk of Powell and some other Fed officials.

This isn’t a call for investors to dump all of their stock shares and hoard cash, though it’s not a terrible idea to have some dry powder ready. If you’re hoping to see a stock market crash in the next few weeks, you’ll probably be disappointed.

Granted, seasonality patterns suggest that September hasn’t been the best month to stay invested in large-cap stocks. But then, who says you have to be heavily allocated into large-caps? There are plenty of small and mid-size investable businesses that are worth a look.

Courtesy: BofA Global Research

Investors can also diversify outside of the world of stocks. Real assets, such as gold, are trading at a discount compared to large-cap stocks and long-term government bonds. And while it may frustrate some traders to see gold still trading below $2,000, I view this as one final opportunity to get in before the next leg of the commodities bull market starts.

Silver below $25 is also a temporary situation that should be resolved in the near future. The Fed isn’t going to cut interest rates tomorrow or next week, but when government bond yields to come down, gold and silver will become comparatively attractive and investors will rush in.

But for now, Powell and other Fed officials will jawbone bond yields higher so they can declare victory over inflation later on. Whether they will actually deserve credit for easing inflation is another matter entirely. What matters now is that real assets are on sale, and pockets of value in the stock market can be found if you look carefully.