‘Confused’ markets get another chance to hear Fed’s Powell ‘flesh things out’ on 2023 rate path

Financial markets will get another opportunity to absorb the prospect of further interest rate hikes this year when Federal Reserve Chairman Jerome Powell steps before Congressional lawmakers, starting on Wednesday.

While Fed policy makers clearly flagged an intent to raise the benchmark interest rate twice more in 2023 at their meeting last week, their decision to skip another rate rise in June left some investors uncertain about the central bank’s inflation-fighting resolve. Though U.S. equities were lower Tuesday afternoon, Fed funds futures traders saw only a slim chance of another hike by year-end, following a quarter-of-a-percentage point increase in July that would lift the main interest-rate target to between 5.25%-5.5%.

Read: ‘Summer doldrums’ in stocks put to the test as doubts linger on more Fed rate hikes and Here’s why U.S. markets might get rattled by a Fed that stops and restarts hiking rates

“Powell has another chance to flesh things out,” said Derek Tang, an economist at Monetary Policy Analytics in Washington. While last week’s Fed decision reflected a consensus among voting members of the Federal Open Market Committee, the market came away from Powell’s press conference “a little confused about why the Fed didn’t hike in June, even though officials saw the need for two more rate hikes.”

The Fed chairman will likely be pulled in two directions during Wednesday’s testimony before the House Financial Services Committee and his appearance in front of the Senate Banking Committee on Thursday, Tang said via phone. “Republicans will be quite keen to criticize the Fed about high inflation, which will have Powell doubling down on guidance, and Democrats will probably say, ‘The Fed has done a lot already and we will have to wait to see how much the economy is going to weaken,’ which backs the case for proceeding more slowly.”

As of Tuesday afternoon, all three major U.S. stock indexes
DJIA,
-0.51%

SPX,
-0.29%

COMP,
-0.04%
were trimming last week’s gains, as investors assessed China’s efforts to support its slowing economic recovery. Dow industrials were down by more than 200 points, or 0.7%, leading the decline in major indexes. Meanwhile, 2- BX:TMUBMUSD02Y through 30-year Treasury yields BX:TMUBMUSD30Y were all lower.

That’s a turnabout from Friday, when the 2-, 10- and 30-year rates ended the New York session higher on hawkish rhetoric from Fed policy makers. Meanwhile, the S&P 500 and Nasdaq Composite logged their longest weekly winning streaks in years last week. U.S. markets were closed Monday for the Juneteenth federal holiday.

See: How U.S. financial markets have performed in the past 15 months as Fed rate hikes fueled wild swings

Ian Lyngen and Ben Jeffery, rates strategists at BMO Capital Markets, said Powell is unlikely to try to shift the Fed’s message so soon after last Wednesday’s policy update from the FOMC. The chairman has been “been effective in signaling that ‘skipping’ this month’s meeting is not an indication that the hiking campaign has ended,” they wrote in a note on Tuesday.

For Tang of Monetary Policy Analytics, the parts of the financial market most vulnerable to reaction from Powell’s testimony this week are the short- to intermediate-term sections of the Treasury market. In particular, short-term yields that capture the next six months could be in for a “pretty interesting jolt if Powell doubles down” on his hawkish message.

By contrast, equities have proven to be “pretty resilient and not that sensitive to what Powell says,” given a fundamentally strong U.S. economy, Tang said. Stock investors “have worked out a way to live with high interest rates as long as the economy is humming along.”