Markets don't yet appreciate the total paradigm shift from Powell
Powell re-wrote the rule book on Wednesday
The Fed isn't going to hike.
That's the singular message from the FOMC decision. Here is the verbatim on what Powell said in what is likely the most-important thing he's said as Chairman:
"We've just touched 2% core inflation to pick one measure, & then we've fallen back. So I think we would need to see a really significant move up in inflation that's persistent before we would even consider raising rates to address inflation concerns."
Let's break that down.
We're at 1.3% y/y on headline inflation and 1.7% in the PCE report. How much is a 'really significant move up'? I'd argue it's at least a full percentage point.
Not only that, he highlights that it would have 'persistent'. So perhaps 2.5% core inflation for at least six months. Maybe even 3%.
And that is before the Fed would even 'consider' hiking rates.
Powell's term runs until Feb 2022. There's almost no way we fulfill all those conditions in time to get a hike.
The rebuttal is: So what, the Fed wasn't going to hike anyway?
Maybe. But consider all the possibilities. There is an entirely-realistic scenario where global growth picks up, the trade war ceasefire holds and inflation ticks higher. If that all happens, Fed is saying they're going to let the economy run hot.
At the same time, you have to take it all with a grain of salt. Almost exactly a year ago, Powell said:
"Interest rates are still accommodative, but we're gradually moving to a place where they will be neutral," he added. "We may go past neutral, but we're a long way from neutral at this point, probably."
The Fed hiked in December and then realized it made a huge mistake and has been walking it back ever since. So Powell's credibility isn't exactly iron-clad.
We could see the same kind of reversal here but I don't think we will because I don't think this is just Powell's belief and I also don't think it will die with his term.
There is a groundswell at the Fed that isn't unconcerned with runaway inflation and is much more concerned with Japanification risks. They would rather shock the economy with 4% inflation than risk being stuck at the zero bound. That's because they know they can tame high inflation with conventional tools if need be while they're running out of tools to fight deflation.
What does it mean for markets? Gold is telling a bit of the story today as it rises above the 55-day moving average in a $14 climb. That's a straightforward trade on a dovish Fed (and, importantly, similar sentiment growing elsewhere). I think there will be some ebbs and flows in that trade because the market is rarely focused on the long-term and this change in stance is undoubtedly long term.
I don't think there is a trade on the Powell shift right now. Eventually it will be gold, equities and emerging market currencies against the dollar. Those will all be good long-term trades but there's no reason to rush into them right now because the market is going to focus on trade and the election for the next year.
For right now, this is something to file away because at some point it will be a game-changer.