As the market digested and dissected each word and phrase Federal Reserve Chairman Jerome Powell read as he presided over the Federal Open Market Committee (FOMC) on Wednesday, it is now more confused and unsure than ever.
Going into the meeting, the market was extremely jittery about the prospect of tapering as a Wall Street Journal article reported as a November possibility. The Fed essentially upgraded its inflation forecasts and lowered its GDP somewhat to reflect the slowing trend and admitted that inflation is a lot higher than it expected. This may seem like new information, but the Fed, outside of former chairman Paul Volcker really, has always played more of a reactionary role than a pre-emptive one. It states things after the fact and reacts only when there is an emergency. It does not have the tools or bandwidth, nor mandate even, to try and call events before they happen in order to avoid any carnage.
The Fed did not raise long-end inflation all that much as it still believes it is transitory. It is debatable how many months qualify as transitory versus permanent, but for the Fed it will choose to hide behind that word as it buys the Fed time. One key feature was that the dot plots in 2022 showed how the Fed is split evenly between raising rates and leaving them alone.
The market had a very strange reaction to the initial headlines as the Fed did say it was looking to taper this year, and yet the market rallied, trying to recapture the 50-day moving average for the S&P 500. It was almost a "travel and arrive" as the market was ready for that announcement.
Gold, copper, oil and even Bitcoin rallied as the headlines hit the tape. During the call, there was a lot of back and forth; Powell is a master at that. However, it is important to read into what he did not say as well as what he did say.
The Fed has two key objectives, namely employment and inflation. It already has achieved the latter goal of averaging 2%, though one can argue it might have achieved even more than that. But it is the former that still requires "substantial progress," in Fed speak. The Fed will not taper or reduce quantitative easing (QE) until it meets its objective of reaching full employment. That means the market may need to wait for another month or two to get better non-farm payrolls for September and October. Only then will the Fed start considering tapering -- provided no other exogenous hiccup happens before then. One never knows with the system, given how leveraged it is. Raising rates is an entirely remote possibility as there is just too much at stake to do so.
So, for the next two months, the Fed is still buying $120 billion per month of assets. It really is that simple as its balance sheet is still increasing and that has been the key driver behind the move in broader markets. Until that stops, the market will not lose its support.
In the past few sessions the focus on China and the Evergrande Group situation has taken prime focus and concern as many are proclaiming it is the "Lehman event" without truly understanding what is going on in China nor what President Xi Jinping's mandate is. It is all about the people and there is no way they will let the entire property market crumble as it constitutes 40% of household exposure. Everyone in the media suddenly becoming Chinese property experts just highlights how exaggerated this story has become. China just injected about 100 billion yuan in liquidity each day over the past four days, which goes to show that it will not let the markets collapse.
The September selloff becomes almost self-fulfilling as everyone expects it from the middle of the month. Once it happens the screams get even louder, almost to the point that when the market rallies it catches them all out of it -- the ultimate pain trade. For now, the liquidity taps are still on. Let's see how soon the average American gets off the couch and gets a job now that Uncle Sam has ended its free handouts, or will Daddy Powell enable them for a bit longer?