Did Markets Overreact To Jerome Powell's Comments On Interest Rates?

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by: Russell Investments

On the latest edition of Market Week in Review, Senior Investment Strategist Paul Eitelman and Research Analyst Brian Yadao discussed U.S. Federal Reserve (the Fed) Chair Jerome Powell's recent remarks on interest rates, the current slide in oil prices and potential market impacts of the Dec. 1 meeting between U.S. President Donald Trump and Chinese President Xi Jinping at the G-20 summit.

Is the Fed shifting its rate-hike plan for 2019?

At a speech to the Economic Club of New York on Nov. 28, Fed Chair Jerome Powell said that the central bank's interest rates are just below the estimated range of the neutral rate - the point at which rates neither accelerate nor hinder economic growth. This statement marked a sharp about-face from Powell's comments on rates in October, when he remarked that the Fed was a long way from neutral.

"I think that Powell's October comments were probably a communication mistake," Eitelman said, noting that the remarks seemed inconsistent with the Fed's prevailing outlook and guidance on interest rates. It's no surprise then, he said, that markets reacted in dovish fashion to Powell's latest comments, with the S&P 500® Index up nearly 4% on the week, as of midday Nov. 30. "All things considered, this was probably a bit of an overreaction on the part of markets, in terms of any expectation for fewer interest-rate increases going forward," Eitelman said. Why?

First of all, with U.S. unemployment at a 49-year low, and core inflation very close to the Fed's 2% target, Eitelman and the team of Russell Investments strategists believe there's still a very strong reason for the central bank to hike at least two more times in order to get rates back up into the neutral zone. Secondly, recent economic data trends point to an uptick in wage inflation, as well as freight costs and other input prices, Eitelman said. "Powell's remarks seem to indicate that after the Fed moves rates back up into the neutral zone, the central bank will become very reliant on economic data as it mulls moving to a restrictive policy stance - and the data we're seeing suggests that inflation will continue to churn upward in 2019," he stated.

What's driving the downturn in oil prices?

Turning to commodities, Eitelman noted that the price of oil has tanked over the past several weeks, with the cost of U.S. West Texas Intermediate crude falling to roughly $50 a barrel on Nov. 30 - down from approximately $75 a barrel at the beginning of October. So, what's behind the price drop? Increased supply and shrinking demand, he said.

"There's been a pretty significant inventory accumulation of oil, with Saudi Arabia in particular overproducing in relation to their OPEC quotas for some time-and that's contributed to an oil glut," Eitelman said. At the same time, global demand for oil has been a little softer than expected, he explained-due in large part to natural disasters in Japan, a slowing Chinese economy and a slew of temporary factors in Europe.

"Going forward, our expectation at Russell Investments is that the energy market should move back into a much greater balance," Eitelman said, noting that OPEC may announce production cuts at its upcoming meeting on Dec. 6. In addition, he believes that the recent softness in Japan and Europe will fade moving into 2019, with an economic rebound possible. These two forces combined, Eitelman concluded, lead him to believe that oil prices may rise back to around $70 or $75 a barrel next year.

All eyes on Trump, Xi meeting

The much-anticipated talks between U.S. President Donald Trump and Chinese President Xi Jinping will occur over dinner Dec. 1 at the G-20 summit in Buenos Aires. The meeting between the two leaders is the main event that markets have been focusing on over the past month, Eitelman noted. While the ultimate outcome is anyone's guess, a best-case scenario for markets would probably be a ceasefire - a three-to-six-month period where Trump and Xi would agree not to slap any additional tariffs on the other country, Eitelman said. "Markets would like such an outcome, because it would put a pause to the uncertainty and allow for government leaders to work toward a trade solution."

The Trump-Xi meeting could also end on a sour note, Eitelman said, with no ceasefire or promise to work toward a new deal. "If this happens, the U.S. could move forward with its final set of tariffs on Chinese goods, which would equate to a full-blown trade war between the two countries," he remarked. In Eitelman's opinion, however, this is probably not the most likely scenario. Were it to occur, however, there would probably be a notable downturn in markets the week of Dec. 3, he said - especially across Europe, Japan and the emerging markets sector.

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