3 key takeaways from Powell’s speech

On the latest edition of Market Week in Review, Director of Investment Strategies, Shailesh Kshatriya, and Responsible Investing Analyst Zoe Warganz unpacked recent remarks by U.S. Federal Reserve (Fed) Chair Jerome Powell on rate hikes and inflation. They also discussed the recent protests in China and key watchpoints for the country's economy moving forward.

Smaller Fed rate hikes possible as soon as mid-December

Warganz kicked off the conversation by noting that Powell's 30 November speech on interest rates and inflation at the Brookings Institution was closely watched by markets, which were looking for signs that the Fed is considering slowing its pace of rate hikes soon. Kshatriya noted that while the Fed chair didn't reveal anything new, Powell's remarks confirmed market expectations of a likely moderation in rate increases, which helped boost U.S. stocks in the wake of the speech.

"Perhaps even more impressive than the rise in equities was the reaction from the bond market, where the yield on the benchmark 10-year Treasury note dropped sharply, from 3.74% the day before Powell's comments to 3.53% at market close on 1 December" he stated.

Kshatriya said that from his perspective, there were three main takeaways from Powell's speech, the first being that the U.S. central bank chair was more forward-looking in his remarks. "Powell indicated that because monetary policy works with a lag, a moderation in the pace of interest-rate increases is probably appropriate soon," he noted. The Fed chair implied that this moderation could occur as soon as the next FOMC (Federal Open Market Committee) meeting on 13 - 14 December, Kshatriya explained, noting that this would potentially mean a 50-basis-point rate hike instead of a 75-basis-point increase. The Fed has opted for a jumbo-sized 75-basis-point rate increase at each of its last four meetings, he remarked.

The second takeaway from Powell's speech is that the federal funds rate will probably peak somewhat higher than projected by FOMC members back in September, Kshatriya said. "A terminal rate in a range slightly above 4.75% looks more likely now," he stated.

Kshatriya said the third takeaway from the Fed chair's remarks is that once rates reach their peak level, they'll probably need to stay at that level for some time. He added that right now, the U.S. labour market is too strong and inflation too high for the Fed to begin easing anytime soon. However, recent data does suggest that progress is being made on both fronts, Kshatriya said, noting that the Fed's preferred inflation gauge – the core PCE (personal consumption expenditures) price index – eased slightly in November.  

On the labour side, October's JOLTS (Job Openings and Labour Turnover Survey) report – released 30 November – showed that the ratio of job openings to unemployed workers dropped to 1.7, he noted. "This ratio is closely watched by the Fed as a key measure of labour-market tightness," Kshatriya explained, noting that the ratio had been as high as 2.0 earlier in the year. While it's since come off its peak, this ratio is still well above the longer-term average, he added.

"Overall, U.S. inflation remains well above the target range of 2%, and the labour market is also still quite robust – but importantly, both are trending in the Fed's desired direction," Kshatriya stated.

Two key watchpoints for China in 2023

Switching to China, Kshatriya noted that the country is recording some of its highest COVID-19 case counts since the start of the pandemic nearly three years ago. Amid this uptick, protests have emerged in several Chinese cities over the nation's stringent zero-COVID policy, he said, leading to a difficult situation for China's government. 

"On the one hand, officials are trying to manage the strain of surging COVID-19 cases on the healthcare system. But at the same time, these restrictions are very hard on both individuals and the economy," Kshatriya stated. He said it appears that policymakers understand the difficulties of the situation, as they've softened quarantine and testing requirements and are also trying to ramp up COVID-19 vaccination rates among the elderly. In Kshatriya's opinion, the emphasis on vaccinating the elderly population is an indication that policymakers could be targeting a reopening of the Chinese economy during the first or second quarters of 2023.

He said that the government is also grappling with a struggling property market, which he noted is an important part of China's economy. To shore up this sector, policymakers recently announced easing measures for developers, Kshatriya said. "While this is encouraging, the problem is that there hasn't been a lot of demand from households due to a lack of confidence - which is due in part to the COVID-19 lockdowns themselves," he explained.

Ultimately, key watchpoints for China moving forward will be how policymakers further support the ailing property sector and what potential measures are introduced to boost household demand, Kshatriya said. "If these coincide with the broader reopening of China's economy next year, that would clearly be a positive," he concluded.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.