Powell’s Dovish Shift Delivers a Powerful Punch

Over the past week, investors have been growing increasingly nervous about the potential for a Fed rate cut in September. While the odds of a cut were still quite high, there was increased chatter about the possibility that market expectations were too optimistic, and the odds of a quarter-point cut had fallen from over 90% to 75%.

Investors expected that Fed chair Jerome Powell would repeat what he has said at the last couple of Fed meetings in his commentary from Jackson Hole on Friday, which is that the Fed is data dependent and that it would decide policy once there was more hard data to consider. Many economists believe that the data so far do not support a cut.

Powell surprised the market by stating that "the balance of risks appears to be shifting.” He stated that the labor markets appear to be stable, but “it is a curious kind of balance that results from a marked slowing in both the supply of and demand for workers.” What was more surprising was that Powell suggested for the first time that the impact of higher goods prices caused by tariffs could be relatively short-lived.

The conclusion was that the unusual combination of increased risks of inflation and a weakening labor could prompt the Fed to support economic growth by reducing interest rates.

To put it more simply, Powell made a dovish pivot. None of the data had changed, but the way that Powell and the Fed were interpreting it has shifted. The most important issue isn’t that the odds of a rate cut in September moved up to 85% from 75%, but that this new thinking by Powell suggests that there will be further rate cuts after September.

Buyers immediately went on a rampage of buying. With the S&P 500 down five days in a row and expectations that Powell wasn’t going to offer much positive momentum, there was plenty of buying to send stocks higher. Breadth was exceptionally strong, and most notably, the move was led by the Russell 2000 IWM small-cap index, which jumped 3.75% and tends to be more interest rate sensitive.

The question now is whether the bulls can build on this big move. Action this strong does tend to produce sustained momentum. There are plenty of skeptics, and we still have negative seasonality to deal with, but the aggressiveness of the buying suggests there are still plenty of investors who want to put more capital to work.

From a technical standpoint, the important issue now is a follow-through day next week that confirms that there is a real change in sentiment and not just a knee-jerk reaction to the headlines. This was heavy index buying on Friday, which is why breadth was so strong.

I’ll be looking for non-extended chart setups for next week. There are still quite a few, especially in the smaller stocks, which are nowhere close to being in a bubble.

Have a great weekend. I’ll see you on Monday.

At the time of publication, DePorre had no positions in any securities mentioned.