Markets Take Powell Comments As Dovish

Markets shifted after slightly dovish comments by Fed Chairman Powell at Friday’s Jackson Hole Symposium speech.

The odds of a September rate cut by the Fed dropped last week as several Fed speakers made hawkish comments. Just one week prior, the odds of a rate cut next month peaked at 98%, but dropped to just 74% by Thursday. On Friday morning, however, Powell hinted at a change in "policy stance" that the market interpreted as a willingness by the Fed to cut next month. Time will tell if that's the correct interpretation. The amount of monetary policy uncertainty indicates that the Fed is playing a very dangerous game at the moment. Similar points of monetary policy uncertainty have accompanied Long-term Capital Management, the 2008 Financial Crisis, and COVID.

On the bright side, stocks had been showing an orderly rotation away from

concentration before Friday's recovery. While the largest companies in the S&P 500 (i.e., Mag 7) had taken a step back, most of the other stocks in the index were trending higher. In fact, more than 70% of the S&P 500 stocks were trading above their 200-day moving average last week, which is a high for the year. New lows on the New York Stock Exchange (that's more than 2,000 companies) never rose above 50 despite the pullback. This also suggests that market breadth is improving and what we just experienced is a short-term event, especially if the Fed comes to its senses and cuts rates next month.

Volatility has been trending lower since the April 7th peak on the VIX. In addition,

Credit Spreads, the difference in yield between corporate bonds and government bonds, are very low - indicating a low risk environment. However, we are about to enter the point in the calendar year when risk typically rears its ugly head. September and October tend to have the largest daily moves, so increased volatility over the next couple of months shouldn't surprise investors. While the Fed may indeed cut rates next month, that may also prove volatile in the short-term. When the Fed has waited more than 5 months between rate cuts, equities have been higher the following month only 54% of the time. However, 12 months following such a rate cut, the market is higher in every instance but one. Investors should temper expectations in the short-term, but have reason to be optimistic towards year-end.

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