Key indicators point towards stock market crash as risk of hawkish Powell looms

As the Jackson Hole retreat approaches on Friday, a sense of uncertainty and apprehension looms over the markets. Federal Reserve Chairman Jerome Powell’s prior speeches have displayed his flexibility in policy agendas, but this year, the indicators suggest a different tone that could contribute to a potential stock market crash.

“He’s going to want to be a little more hawkish than neutral. But he’s not going to deliver what he delivered last year. The market has gotten the memo,” said Quincy Krosby, chief global strategist at LPL Financial.

Powell’s past addresses have been characterized by policy swings spanning the spectrum, but this year, expectations are for a more moderate stance. With inflation tapering and the economy robust, Chairperson Powell might adopt a pragmatic, middle-ground approach, embracing a “call-’em-as-we-see-’em” posture, a practice of adopting an approach that is straightforward, honest, and transparent. Joseph LaVorgna.

Chief Economist at SMBC Nikko Securities America, predicts Powell’s strategy to maximize flexibility and avoid painting himself into a corner. “I just think he’s going to play it about as down the middle as possible,” LaVorgna said .

“That just gives him more optionality. He doesn’t want to get himself boxed into a corner one way or another.”

Market jitters are palpable, evident in the recent stock selloff and rising Treasury yields. Last year’s speech was followed by a 2% drop in the S&P 500 before the event and a further 5.5% decline afterward. Nonetheless, Powell’s resolve seems unshaken. The ongoing transition toward restrictive rates and market alignment with the Fed’s rate projections mitigate immediate pressure. Market narrative dynamics have shifted, curtailing the urgency for the Fed to counteract anticipated imminent easing.

Morgan Stanley’s Seth Carpenter asserts that Powell must maintain a hawkish stance at Jackson Hole. The markets now acknowledge the Fed’s resolute stance against inflation and await substantiated evidence of sustained price increases. However, Powell faces a delicate balance – assuring that past inflation mistakes aren’t replicated while avoiding overly stringent rhetoric that could inadvertently trigger a recession.

Inflation’s recent downtrend is under scrutiny. Energy prices’ ascent and the waning impact of certain deflationary contributors could reverse the slowdown. Surging bond yields hint at potential inflationary spikes. Simultaneously, consumers grapple with mounting credit card debt and the impending depletion of government stimulus savings. Even with real wage growth, inflation’s shadow remains, threatening the value of increased income.

Powell’s leadership guides a Fed leaning toward higher rates, albeit with potential cuts on the horizon. Despite some advocating a pause, others, like Philadelphia Fed President Patrick Harker, believe the Fed’s recent tightening measures should be absorbed before contemplating further changes. This balance highlights Powell’s challenge to signal commitment to inflation control without stifling economic growth.

The markets anticipate Powell’s message. Asia-Pacific stocks faltered, and the dollar surged as investors prepared for his potentially hawkish rhetoric. Powell’s influence on currency valuation is evident as the dollar soared against major counterparts. The Fed’s campaign against inflation spurs uncertainty, emphasizing the need for market transparency.

The probability of a 1987-level crash, though, appears slender. Shiller’s survey reveals that the majority anticipates higher-than-10% odds, reflecting increased risk perceptions after recent bear markets. Xavier Gabaix’s study implies a minuscule 0.33% likelihood of such a crash. The surge in crash anticipation could be linked to neuroeconomics, where losses induce pessimism more intensely than gains spark optimism.

Interestingly, Shiller’s crash-confidence index emerges as a contrarian indicator. Historical analysis shows that when investors were more worried about a crash, the subsequent one-, three-, and five-year market performance improved. While this index might not precisely forecast short-term market movements, it highlights the potential for stronger long-term market trends.

As Powell steps onto the stage, the financial world remains on edge. With nuanced market dynamics and cautious anticipation, the risk of a hawkish Powell impacting the stock market looms large. Balancing inflation control, economic growth, and market stability will test Powell’s strategic prowess. His measured address will determine whether the markets are faced with a storm or a serene outlook in the coming months.

The speech will start Friday about 10:05 a.m. ET.