Keeping Inflation Down in the (Jackson) Hole

(Today’s theme song: “Way Down in the Hole”, by Tom Waits)

We came into this week with two major “known unknowns” on everyone’s radar.  The first was Nvidia’s (NVDA) earnings report, the second is Chair Powell’s address to the Kansas City Federal Reserve’s Jackson Hole conference.  NVDA earnings somehow managed to be both more and less consequential than anticipated; this morning’s sell-off may be an indication that Powell’s speech is more concerning to investors than we had thought.

Before we address our thoughts about what to expect from Powell, we must consider the price action that we have seen since NVDA reported after yesterday’s close.  Taking into account NVDA’s steady and steep climb in recent days, we noted yesterday:

But the question for later today and tomorrow is whether the already lofty expectations are correct.  After the recent upswings it seems as though investors expect some incremental boost beyond the already stellar guidance offered by the company. 

It was admittedly shocking to see that NVDA beat on virtually every metric AND guided revenues and profits even higher.  I can’t recall seeing a company coming into a report with such lofty expectations and then thoroughly blowing past them.  Clearly many traders agreed since the stock rallied as much as 10% after the close and overnight. 

Yet it is important to remember an adage we have used before:

                Traders react, but investors consider.

After digesting the full report and the conference call, many investors obviously decided that despite its beat and raise, much of the optimism had indeed already been priced into NVDA.  As I write this at midday, the stock is up a modest 2%.  That is much better than the broad market, but part of the headwinds facing equities today is that investors have decided that NVDA’s success might be idiosyncratic.  As a result, we see the other mega-cap techs joining the majority of other shares trading lower this morning.

So, with NVDA behind us, we now train our focus onto the mountains of Wyoming.  The financial news media have arrived, and we have begun seeing interviews with well-known economists and financial decision makers.  Comments from Philadelphia Fed President Harker, former St. Louis Fed President Bullard, and Boston Fed President Collins have all expressed the opinion that rates will need to remain elevated for some time.  In other words, “peak and pause do not mean pivot.”  Even though the combination of rates hikes and quantitative tightening (QT) has improved the inflation picture, the job is not over.  Inflation remains above the Fed’s 2% target, and we have gotten no indication that they are adapting that view anytime soon – despite market hopes for a target of 3% or more.

Considering Powell’s previous comments and last week’s release of the minutes of the most recent FOMC meeting, it is difficult to imagine him doing much other than reminding the market that even if rates are held at current levels, they are liable to rise if necessary, and unlikely to fall unless either their inflation target is met, or economic circumstances become dire enough to warrant a rate cut.   I stand by the comments I made to a reporter immediately after FOMC minutes:

The Fed has no choice but to keep it up until they are convinced that inflationary expectations are quashed… Doing otherwise risks some of the embers reigniting. Even though two governors favored keeping rates steady in July, it is important to keep in mind that a pause is not a pivot.

Extending the analogy further (and with consideration to those affected by North America’s various wildfires), if the Fed were to abandon its restrictive policies and assiduous rhetorical stance now, it would be like firefighting crews putting away their hoses when a major fire is 80% contained.  The conflagration is much more subdued at that point, but the crews don’t stop their work until the fire is out. 

It is also important to remember how last year’s conference transpired.  Investors were hopeful that Powell would offer some respite from difficult market conditions, and instead, he gave a terse speech outlining his resolve.  We wrote about it in these three pieces, Can “Goldilocks in a Suit” Keep the Bears Away, written the day prior to his speech, Goldilocks: “Stop Doubting My Resolve to Cool the Porridge”, written in its immediate aftermath, and Goldilocks Feeds the Bears, written the following Monday.

One thing I failed to appreciate at the time, but I believe to be quite relevant, is that Powell delivered last year’s speech directly to the camera while standing in a prairie.  His press conferences avoid outright confrontation with a roomful of reporters, which causes him to offer two sides of a point, and allows the market to focus upon the part of the answer that it likes.  In this address there is no one to appease or confront.  He makes his points and leaves.

It was odd to see investors so sanguine ahead of NVDA’s earnings.  In contrast, we are seeing some risk aversion ahead of Powell’s speech.  Perhaps that will soften the inevitable blow.  Or not.