Fed Chairman Jerome Powell sparked a huge stock market rally after he delivered just the message investors wanted to hear — that the Fed will be flexible on policy and it is in no hurry to raise interest rates.
Stocks were already rallying but the Dow surged several hundred more points after Powell changed his tone on Fed policy, walking back a comment he made in December that rattled markets and made him sound rigid about the Fed's balance sheet.
Following the Fed's December meeting, Powell had said that the central bank's balance sheet wind-down was on "autopilot." He reversed that impression and reassured investors Friday that the Fed would be flexible with all of its policy tools, including the balance sheet.
Powell also said the Fed is monitoring activity in the markets, and while they reflect a more negative view than the economic data, the Fed will take financial conditions into account. Powell was also criticized by market pros for seeming insensitive to the sell-off that took the into a bear market decline of 20 percent on an intraday basis in December.
"We're listening carefully with – sensitivity to the message that the markets are sending and we'll be taking those downside risks into account as we make policy going forward," Powell said.
Julian Emanuel, chief equities and derivatives strategist at BTIG, said he believes that the Fed will hold off on rate hikes this year, and that it will announce it will stop unwinding its balance sheet in June. After Powell's comments, Emanuel said he was even more convinced of that call.
"Certainly, the market feels better about the fact that the Fed is moving towards its view on the hiking cycle. which is that it's largely over. From that perspective it decreases the possibility that the Fed is going to hike too far like it did in 2004 and 2006, it did in 2000 and it did in 1974, triggering broader stock market downturns and recessions," said Emanuel. "That's making people feel better and from our point of view, it makes it more likely that the technical bear market we've seen ... is going to be a shorter, shallower non-recessionary bear market."
The "autopilot" comment unnerved some investors who had been concerned about financial market turbulence and expected Powell in December to acknowledge that the Fed could be flexible with all of its tools. At the same meeting, the Fed had raised interest rates by a quarter point and reduced its interest rate forecast for 2019 to two hikes from three.
Powell gave context to the comment Friday, saying the Fed had intended the interest rate policy to be its active tool while it could allow the balance sheet wind-down to run in the background. "Some years ago, we decided that rate policy was going to be the active policy tool and the balance sheet would be allowed to shrink gradually and predictably in the background," he said.
Speaking at the American Economic Association annual meeting Friday, Powell said the Fed is able to "adjust policy quickly and flexibly" if it sees problems.
"We wouldn't hesitate to change it and that would include the balance sheet. We're hearing a lot from different groups of people about the role the balance sheet normalization may be playing in the market," Powell said. He explained that the Treasury issues more securities when the Fed's balance sheet holdings mature. "We don't believe our issuance is an important part of the story in the market turbulence that began in the fourth quarter of last year."
"If we came to the view that the balance sheet normalization or any other aspect of the normalization was part of the problem, we wouldn't hesitate to make a change," he said. Powell was speaking on a panel with former Fed Chairs Ben Bernanke and Janet Yellen.
The Dow, already up on positive trade news and a strong jobs report, moved sharply higher as Powell spoke. Treasury yields, also higher on the surprisingly strong December jobs report, advanced in tandem with stocks. The yield, the most sensitive to Fed policy, rose to 2.48 percent.
"He invoked the signature word from Chair Yellen's tenure – patient. She would use that in every statement they made — gradual and patient. He hasn't used the word patient, and he invoked it today and it was music to the market's ears," said Quincy Krosby, chief market strategist at Prudential Financial.
"That's clearly moving the market. we know he's flexible on rates, saying he's flexible with the balance sheet is different than saying he's on 'autopilot' ... he's basically pulling back the comment on 'autopilot' and that's what the market is saying right now," said Peter Boockvar, chief investment officer at Bleakley Advisory Group.
Powell also said the Fed had no preset path for policy and could be patient when it comes to interest rate hikes, also seen as a dovish comment.
"We're seeing signs [the Fed] gets it. It was the absolute mirror image of the press conference last month," said one market pro.
The dollar moved lower, as the market viewed Powell's comments as more dovish. Powell also discussed inflation as being muted, also a dovish comment, suggesting the Fed will not be in a hurry to raise interest rates.
"He clearly made an effort not to spook the market. He also mentioned flexibility in terms of the balance sheet, which the equity market likes," said Ian Lyngen, head of U.S. rates strategy at BMO.