The Fed’s Powell triggered a 1,000 point rout in the Dow Jones. Here’s what investors should do next.

Now might be a good time to consider hiding in short-term Treasuries or corporate bonds and other defensive parts of the stock market.

On Friday, Federal Reserve Chairman Jerome Powell spoke of a willingness to inflict “a bit of pain” on households and businesses in an unusually blunt speech from Jackson Hole that hinted at a 1970s-style inflation debacle unless the central bank can rein in sizzling price gains close to the highest levels for four decades.

Lily: Fed’s Powell says lowering inflation will hurt households and businesses in Jackson Hole speech

Powell’s strident stance has prompted strategists to seek the best possible plays investors can make, which may include government notes, energy and financial stocks and emerging market assets.

The Fed Chairman’s drive to essentially break up parts of the US economy to curb inflation “obviously benefits the front-end” of the Treasury market, where rates are rising alongside expectations of Fed rate hikes, said Daniel Tenengauzer, head of market strategy for BNY Mellon in New York.

In his view, the 2-year Treasury yield
TMUBMUSD02Y,
3.391%

hit its highest level since June 14 on Friday, at 3.391%, after Powell’s speech – reaching a level last seen when the S&P 500 officially entered a bear market.

Investors could consider playing on the credit markets front, such as commercial paper and leveraged loans, which are floating-rate instruments – all of which are benefiting from the “clearest direction in the markets right now.” “Tenengauzer said by phone. . He also sees demand for Latin American currencies and equities, as central banks in that region are further along in their rate-hike cycles than the Fed and inflation is already starting to fall in countries like Brazil.

A battle cry from the Fed

Powell’s speech is reminiscent of Mario Draghi’s “do whatever it takes” battle cry ten years ago, when he pledged, as President of the European Central Bank, to preserve the euro during a crisis sovereign debt crisis in his region.

Attention now turns to next Friday’s nonfarm payrolls report for August, which economists say will show a gain of 325,000 jobs after July’s. unexpected reading of 528,000 readings. Any gain in nonfarm payrolls above 250,000 in August would bolster the Fed’s case for further aggressive rate hikes, and even a gain of 150,000 would be enough to generally keep rate hikes going, economists and analysts said. investors.

The labor market remains “unbalanced” – in Powell’s words – with the demand for workers exceeding the supply. The August jobs data will offer a glimpse of how this could be delayed further, which would reinforce the Fed’s No. 1 goal of bringing inflation down to 2%. Meanwhile, continued rate hikes risk tipping the U.S. economy into a recession and weakening the labor market, while cutting the time Fed officials may have to act forcefully, some say. .

“It’s a really tricky balance and they’re now operating in a window because the labor market is strong and it’s pretty clear that they should be pushing as hard as they can” on interest rates. higher, said Brendan Murphy, the North American head of global fixed income for Insight Investment, which manages $881 billion in assets.

“All else equal, a strong job market means they need to push harder, given the higher wage backdrop,” Murphy said by phone. “If the labor market starts to deteriorate, then the two sides of the Fed’s mandate will be at odds and it will be harder to increase aggressively if the labor market weakens.”

Insight Investment has been underweight bond duration in the United States and other developed markets for some time, he said. The London-based firm is also taking less interest rate exposure, staying in yield curve flattening trades and selectively overweighting European inflation markets, particularly Germany.

For Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York, the best combination of plays investors could take in response to Powell’s Jackson Hole speech is “to be aggressive in materials/energy/ banks/some emerging markets and defense in dividends/low volume equities (think health)/dollar long.

“Provisional Signs”

The depth of the Fed’s commitment to support its campaign to fight inflation collapsed on Friday: Dow Industrials
DJIA,
-3.03%

sold 1,008.38 points for its biggest decline since May, leaving it, with the S&P 500
SPX,
-3.37%

and compound Nasdaq
COMP,
-3.94%
,
nursing losses weekly. The Treasury curve inverted deeper, down to minus 41.4 basis points, with the 2-year yield hitting nearly 3.4% and the 10-year rate
TMUBMUSD10Y,
3.034%

was little changed at 3.03%.

For now, the inflation and employment components of the Fed’s dual mandate “point to tighter policy,” according to US economist Michael Pearce of Capital Economics. However, there are “tentative signs” that the US labor market is beginning to weaken, such as an increase in jobless claims compared to three and four months ago, he wrote in an e-mail. email to MarketWatch. Policymakers “want to see the labor market weaken to help bring wage growth back to rates more consistent with the 2% inflation target, but not so much as to generate a deep recession.”

With an unemployment rate of 3.5% in July, one of the lowest levels since the late 1960s, Fed officials still appear to have ample leeway to continue their battle against inflation. Indeed, Powell said the central bank’s “overarching” goal is to get inflation back to its 2% target and that policymakers will hold on until that is done. Furthermore, he said they would use their tools “forcefully” to achieve this, and failure to restore price stability would lead to greater pain.

Front Loading Rides

The idea that it might be “wise” for policymakers to anticipate rate hikes while they still can seems to be what drives Fed officials like the Minneapolis Fed’s Neel Kashkari and James Bullard of the St. Louis Fed, according to Derek Tang, an economist at Monetary Policy Analytics in Washington.

Thursday, Bullard told CNBC that, with the job market strong, “this seems like a good time to get to the right neighborhood for the funds rate.” Kashkari, a former dove who is now one of the Fed’s top hawks, said two days earlier that the central bank should continue its tightening policy until inflation clearly falls.

Luke Tilley, Philadelphia-based chief economist for Wilmington Trust Investment Advisors, said the upcoming nonfarm payrolls report could be “high or low” and that still wouldn’t be the main factor behind the Fed officials’ decision on the magnitude of the rate. hikes.

What really matters for the Fed is whether the labor market shows signs of easing from its current tight conditions, Tilley said by phone. “The Fed would be perfectly fine with strong job growth as long as it means less pressure on wages, and what they want is for there not to be such a disconnect between the supply and demand. Hiring isn’t a big deal, it’s the fact that there are so many job vacancies available to people. What they really want to see is a mix of weaker labor demand, lower job vacancies, higher labor market participation and less pressure on wages.

The week ahead

Friday’s August jobs report is the culmination of data for the week ahead. There are no major data releases on Monday. Tuesday brings the S&P Case-Shiller home price index for June, the August consumer confidence index, July jobs and quits data, and a speech from the Fed Chairman of New York, John Williams.

On Wednesday, Loretta Mester of the Cleveland Fed and Raphael Bostic of the Atlanta Fed speak; the Chicago Manufacturing Purchasing Managers Index is also released. The next day, the first weekly jobless claims, US S&P Global manufacturing PMI, ISM manufacturing index and construction spending data for July are released, along with other remarks from Bostic. On Friday, July Factory Orders and a review of Core Capital Goods Orders are released.

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