“Today’s prices are wrong” is the central tenet of active portfolio management. Without that belief, no manager could justify his or her role in capital markets. Systematically identifying mis-priced assets is the first line of a PM’s job description.
At the same time, investors have grown accustomed to questioning the existence of rampant asset price inefficiencies. That has driven the growth of passive management, of course. But it has also made “what’s your investment edge?” the only question that matters when quizzing everyone from a junior hedge fund analyst to the most senior long-only manager.
Markets made a harsh assessment today: Fed Chair Jay Powell has no edge. To be fair, that judgment actually started in early October, when Powell offered his “far from neutral rates” comment. The S&P 500 is down 14% since then. Today’s 1.5% drop was just the equity market’s way of saying “you are missing important information”.
Six quick thoughts to expand on this, all based on Chair Powell’s answers to various questions during the post-meeting press conference:
#1. Not only did the Chair shrug off markets, he also discounted commentary from the Fed’s own business contacts. Powell mentioned that there is a “mood of angst” as he speaks to companies just now. But he brushed aside these sentiments, noting that they may not last. He also mentioned the difficulty of measuring business confidence with enough precision to incorporate it more robustly in Fed rate discussions.
#2. When questioned about still-quiescent inflation and the Fed’s consistent over-estimation of this half of their dual mandate, Powell could only say (essentially) “Well, we’re pretty close to 2%”. In the Fed’s latest Summary of Economic Projections (SEP) out today, the FOMC actually lowered its inflation expectations for next year to 1.9% from 2.0%. Against that lower comp, the Chair struggled to explain why the committee still thought 2 rate increases next year were appropriate.
#3. While Chair Powell stressed that the Fed looks at a variety of market indicators, he seemed unconvinced that recent simultaneous moves in US stocks and Treasury yields were telling a compelling story about recession probabilities. Market volatility can be transient, to be sure. The Chair said that the only valid signal will come if long term interest rates remain low, signaling a change in the bond market’s expectations for future growth and inflation. But since investors know monetary policy only works with a lag, they are rightly concerned it will be too late by then.
#4. The market’s key worry that the Fed is overly reliant on a specific (bullish) outlook got a boost from the Chair’s comments about the Fed’s balance sheet. The current $50 billion/month reduction will remain in place. In his view, that consistency helps the bond market digest the runoff. But it was another signal that the Fed thinks asset prices are too negative on the US economy.
#5. The committee’s SEP contributed to confusion about the Fed’s future rate path. This was a problem we highlighted in Sunday’s note: how does the Fed reduce their guidance on future rate hikes without causing undue concern about 2019 economic growth?
Their answer was to cut GDP growth expectations to 2.3% (from 2.5%) and inflation to that 1.9% estimate (from 2.0%). But those changes caused several reporters to ask why the Fed needed to raise rates at all, and the Chair didn’t have a great answer except to offer up the “data dependent” hedge and say there was a “fair degree of uncertainty” just now.
#6. There were more questions on the “neutral” (neither stimulative nor restrictive) rate of interest than any other topic, an intellectual quagmire with no clear answer. All the Chair could say was that after today the Fed Funds rate is at the lower end of the committee’s long run estimate. Markets found that to be slim comfort since the Fed has two more rate increases penciled in for next year.
Summing up with one charitable (and important) point about Chair Powell’s performance today: no Fed Chair can ever say “Winter is coming”. He must take the other side of the current bearish trade in stocks and bonds. To do otherwise would only hasten an economic slowdown as companies and individuals followed the Fed’s lead. Regardless, markets were looking for more signals from Chair Powell that he hears their concerns. He is now in a tough spot. How investors view his leadership is now as data-dependent as the Fed’s future rate policy. He owns the bullish case now. He needs to be right.