Wall Street appeared to quickly get over its initial disappointment that Biden didn’t appease progressives and take what may have been a “less hawkish” option of appointing Lael Brainard.
After forming bearish key reversal patterns at record highs as bond yields jumped on the news, the S & P 500 and Nasdaq rebounded fairly smartly and the Dow had a decent rise.
Powell can’t yet be accused of a classic “policy error” in terms of tightening monetary policy so slowly or quickly that it causes a recession, but there were a couple of incidents in his first term which caused consternation to global markets and had to be walked back by the Fed.
His first mistake was the October 2018 comment that the Fed was “a long way” from getting interest rates to neutral.
That suggested to investors that a rapid and bigger than expected period of rate rises were in store, causing the S & P 500 to fall as much as 11 per cent over the next few weeks.
Another mistake was arguably made in the FOMC minutes of November 2018. Released late that month, the minutes said the Fed committee’s post-meeting communications might need to be revised, particularly in regard to members’ expectations of “further gradual increases” in the Fed funds rate.
This was like the Grinch that Stole Christmas and didn’t go down well.
The S & P 500 unusually fell as much as 16 per cent from December 3 to December 26, a sell-off during which the Fed lifted rates – as it signalled – on December 19, but also dialled back its projections to two more increases in 2019 rather than its September forecast of three increases.
By February 25, 2019, the S & P 500 had fully recovered but it was a stressful Christmas for markets.
Bell Potter’s head of institutional sales and trading, Richard Coppleson, says that was a “sneak preview” of what markets will do if they worry that the Fed is getting close to lifting rates, “because once they start it will not be just one”.
“With the huge amounts of cash, the punch bowl (record low rates) being taken back out of the system and the massive amounts of leverage across the globe means there could be a very adverse reaction as we saw in late 2018 in equity markets,” he says.
Coppleson says it comes down to how well the Fed can broadcast when the rate rises will come.
“If inflation forces their hand and they have to hike earlier than previously thought, then that’s when we could see things getting unwound and fast,” he says.
“For now they have been clear but the market thinks they are behind the curve and if they have to suddenly move quicker and harder markets will have already be whacked before then.”
According to JPMorgan’s co-head of global research and chief global markets strategist, Marko Kolanovic, Powell’s reappointment reduces uncertainty, and hence should be a positive for risk assets.
“Markets try to test new Fed chairs, so we believe this outcome will be avoided,” he says.
“Additionally, Powell’s experience from the second half of 2018, where policy tightening contributed to the strong market sell-off into year-end will likely result in a cautious approach to lift-off next year.”
Kalonovic says Fed tapering is less worrisome for stocks than in the 2013 episode – which was delayed until 2014 – as concerns about excessive hawkishness are unwarranted and the growth cycle appears more durable.
“We see global yield curves re-steepening as the growth outlook improves, which supports our thesis of internal rotation toward cyclicals and value,” he says.
Apart from having a steady hand at the Fed, he is hopeful of easing US-China tariffs.
Markets are notoriously hard to profit from when the crowd is already on-board, but lower tariffs under Biden are a “potential non-consensus equity tailwind – particularly for US cyclicals and small caps, boosting growth on both sides and helping moderate inflation”.
Kalonovic says the benefit to US stocks’ earnings would be “material”.
While lessening tariffs might be difficult amid heightened geopolitical tensions, perhaps the US and China may find some common ground as they have this week on strategic oil reserve releases.
Easing the trade war would simultaneously boost margins and easing supply chain issues, with the sectors that have been most impacted by the trade war potentially standing to gain the most.
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Jerome Powell’s renomination was in many ways the safe choice for US President Joe Biden, not least because the Fed chair is unlikely to repeat the mistakes of his first four-year term.