US stocks have been on a roller coaster ride after Fed Chairman Powell’s testimony signaled that the Fed will “in all likelihood” normalize its policy, while allowing the balance sheet to run off later this year. The Fed sees inflation lasting until mid-2022 and that is probably when it will let the balance sheet fall.
Wall Street now has a better understanding of how the Fed will normalize its policy and the balance is expected to take up to four meetings. After Powell’s testimony, some investors believe they have received the clear signal to buy the bearish. The Fed’s tightening window is complicated given that inflation may finally peak over the summer and may not want to look political and be too aggressive in removing accommodations so close to the election of. mid-term.
Investors are still very bullish on three key things: Household and business balance sheets remain very healthy, the next earnings season is expected to be strong, and the economy will still experience above-trend growth, even if the Fed raises rates. three times and begins the flow of the balance sheet. in summer.
The act of opening Fed Powell chairman’s confirmation hearing for a second term had a few hawks, Bostic and Mester both laid the groundwork for a takeoff in March, while George supported a runoff of the balance sheet earlier.
Early this morning, the Fed’s Bostic told Bloomberg: “We are ready to act to make sure inflation does not slip away.” He added that they “should be comfortable and looking to shrink the balance sheet fairly quickly after we take our interest rate take-off.”
George of the Fed said: “My own preference would be to go for a balance sheet sooner rather than later as we chart a course to remove monetary accommodation.”
It was a very hawkish opening act that should support the takeoff of ideal rates in March and the reduction in the balance sheet begins in June.
The testimony of Fed Chairman Powell began by tackling inflation. He reminded financial markets that the constraints on the supply side have been very long-lasting and persistent, noting that the number of vessels at anchor is at record levels. He explained why they were wrong that inflation was transient, noting that the situation is unprecedented.
Powell believes the Fed will take steps to normalize its policy this year. Wall Street knows rate hikes are coming and expectations are now at 85% for a rate hike in March.
Regarding the labor market, Powell said, “What we have is a labor supply problem. The Fed can tick the maximum employment box and now just focus on inflation.
Powell noted that a decision on reducing the balance sheet could take two to four meetings, suggesting that the June meeting will become the baseline scenario for many traders.
Overall, Powell wasn’t overly hawkish as he paved the way for a long debate about shrinking the balance sheet, with his comments on normalization taking away some of the importance of tomorrow’s hot inflation report.
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