Opposition to Powell’s speculation comes almost immediately

(Bloomberg) — Within hours of the Federal Reserve’s latest policy decision, traders and commentators alike began challenging Chairman Jerome Powell’s assessment of the economy.

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The bond market brushed off the possibility of Powell making one last raise up his sleeve, and instead added to bets that the US central bank’s next move would be a record rate cut. The drop in crude oil prices indicates growing concern about a recession, which the Fed chief said could be avoided. Financial stocks plunged again even after Powell saw a line drawn in the turmoil of US banks.

There is a growing possibility of a recession, Jeffrey Gundlach of DoubleLine Capital told CNBC, and it is likely that the Fed will not raise interest rates again after its recent increase. Meanwhile, at the Milken Institute’s global conference, talk among panelists suggested a consensus view that deflation was inevitable.

WTI fell 4.3% on Wednesday, reflecting concerns about weak economic growth in major economies. It plunged as much as 7.2% in open market chaos on Thursday before recovering.

“Our view is technical stagnation, when the question mark is,” said Lindsey Rosner, multi-sector portfolio manager at PGIM Fixed Income. If Powell has just laid out the framework under which they operate is one of modest growth, not a recession, that could indicate that they need to change course if they see a recession. That’s why we think they’ll have to cut.”

To be fair to Powell, he hinted that Wednesday’s rate hike, which lifted the benchmark interest rate above 5%, could be the last in a cycle that lifted borrowing costs from near-zero levels last year. And while the Fed chair said there was strong support for a 25 basis point rate hike this week, he signaled that officials may pause their tightening campaign in June.

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Powell also acknowledged that the pace of bank lending has slowed. And US economic data, while indicating a slowdown in the labor market, does not yet indicate that a recession is at hand.

Quick response

But the news moves quickly and traders will not anticipate rather than wait to see how things play out.

Treasurys rose on Wednesday as investors ramped up bets that federal interest rates will be lower by the end of this year, despite Powell’s insistence that the central bank’s inflation outlook does not support an easier policy. By the end of the day, the June swaps were pointing to a lower effective federal funds rate.

Meanwhile, a Bloomberg News report that Backwest Bancorp was weighing its strategic options compounded concern that unrest among smaller US banks could lead to more victims and a tightening of credit conditions.

Four US banks have collapsed since early March, including First Republic Bank, which was seized this week by federal regulators. Powell described the First Republic’s decision as “an important step toward drawing a line” in light of the banking turmoil.

However, the PacWest report sparked fresh selling in financial stocks in after-market trading.

“The market will be looking for signs that tightening credit is starting to affect activity and labor market data,” said Vasily Serebryakov, foreign exchange and macro strategist at UBS Securities in New York. “As the Fed hinted at a pause today, any weakness in the data will reinforce the view that the tightening cycle is over.”

Powell said Wednesday that it is possible for the US to see what he hopes will be a mild recession, but that “a recession avoidance is in my opinion more likely than a recession.” He said that wage increases are declining and job opportunities have decreased, but they have not been accompanied by an increase in unemployment.

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But attendees at Milken’s conference voiced their concerns. Guggenheim Capital Chairman Alan Schwartz told Bloomberg Television that he is concerned about the effects of tightening credit and the extent to which banks will pull back. Jenny Johnson, CEO at Franklin Templeton, also pointed to the stress in the banking system caused by the pace of the Fed’s increases and the potential for further cuts as a result.

Gundlach, co-founder of DoubleLine Capital, cited the cumulative interest rate increases by the Federal Reserve since March 2022 and the credit contraction as reasons why it is “bearish at this point in time.” He said the Fed will likely not raise interest rates again after its recent increase. “The potential for a recession is very high right now.”

– With assistance from Matthew Bossler, Rob Verdonk, Michael McKenzie, Brandon Sapienza, Stacy Schick and Matthew Burgess.

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