Powell statements confirm challenging environment for equities Powell statements confirm challenging environment for equities Powell statements confirm challenging environment for equities

Powell statements confirm challenging environment for equities

Peter Garnry

Head of Saxo Strats

Summary:  Powell was clear yesterday saying that it is premature to even think about pausing rate hikes as inflation goes to surprise to the upside relative to the Fed's model forecasts. Despite much tighter financial conditions the US economy is still going strong with a labour market that is still significantly more tight than the pre-pandemic level suggesting wage pressures will continue to cause headwinds for companies and keep inflation higher for longer. Equity valuations are around the long-term average since 1995 suggesting more downside risks to equities as interest rates will likely increase, margins will continue to decline, and revenue expectations may cool.

Dissecting the FOMC press conference and what it means for equities

Equities rallied initially on the FOMC press release revealing a 75 basis points hike to 3.75-4% target range and the need for ongoing hikes until rates are sufficiently restrictive, but during the press conference Fed Chair Powell steered the narrative in a completely different direction. Powell said that the Fed still had some ways to go on rates and that the ultimate rate level was going to be higher than previously expecting touching on a pattern that the Fed’s models have continuously been wrong. Powell basically said that he does not trust the current forecasts and that it is very premature to think about pausing rate hikes. The reaction has been a 25 basis points move higher in the expected Fed Funds Rate in December 2023 (see chart) suggesting the market is revising up its terminal rate projection. If the error in inflation forecasts continue with the pattern Powell suggests then this rate will likely continue higher to reflect the ‘higher inflation for longer’ narrative.

In addition to these statements on rates Powell said that the window of ‘soft landing’ in the economy is narrowing suggesting the Fed sees that it is increasingly getting more difficult to set the economy up for soft landing while taming inflation. ECB President Lagarde is also out saying today that a mild recession is not enough to tame inflation to desired levels suggesting two natural trajectories in the economy and central bank policies. Either central banks let inflation run higher for longer pausing rates at levels creating a soft landing but anchoring inflation at higher levels for longer, or they keep hiking until the economy goes into a deeper recession. Both trajectories are bad for equities but the latter has more negative dynamics than the first.

What has been remarkable is the extent to which the US economy has been able to absorb tighter financial conditions. Despite a regular interest rate shock, Powell’s preferred measure on the US labour market is still indicating that the labour market is red hot and very tight suggesting wage pressures will continue for a prolonged period keeping inflation higher for longer. The measure Powell has been speaking about is the total job openings in the US economy relative to number of unemployed workers. This measure is still 56% higher than the pre-pandemic level which in itself was indicating the tightest US labour market since at least 2002.

Source: Bloomberg

The triangle of discount rate, growth and margins

Equities have three dominant drivers of valuation with the discount rate being the biggest influencer of equity declines over the past year. Margins are clearly rolling over in recent earnings seasons as wage pressures and commodity prices are squeezing companies’ ability to pass on all of the costs. That means that the only opposite force to lift equities has been revenue growth expectations which are directly linked to the probability of a recession. The recent rally in equities has been linked to the ‘soft landing’ narrative as economic data are suggesting the economy is growing at trend growth despite tighter financial conditions.

But with Powell’s statement about the window is narrowing for a soft landing and higher terminal rate the equity market will soon be under pressure from both higher discount rate, lower revenue expectations, and margins rolling over. Our medium term outlook of the S&P 500 hitting the drawdown cycle low at the 3,200 level is still our base case scenario.

S&P 500 futures | Source: Saxo

Equity valuations sit on the average since 1996

On a monthly basis we update our valuation model on global equities consisting of seven different valuation metrics in order to gauge the overall valuation level and what it potentially means for future returns. As of October, the MSCI World was valued just around the average since 1995 after peaking out in February 2021 at 1.67 standard deviations above the average. The current equity valuation level adds to downside risks in equities as the current level in the US 10-year yield is now above the long-term average since 1995 and will likely continue higher given Powell’s statements yesterday. With an above average interest rates and inflation environment coupled with increasing risks of lower economic growth we expect equity valuations to compress even further.


The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992