Stock market participants had been looking forward to Wednesday for quite a while, as they anticipated getting valuable insight when Federal Reserve chair Jerome Powell gave a speech about his views on monetary policy. As it turned out, Powell's comments were well-received by investors, and that resulted in solid gains of more than 2% for the Dow Jones Industrial Average (^DJI 0.01%) and even bigger advances for the Nasdaq Composite (^IXIC 1.10%) and S&P 500 (^GSPC 0.70%).


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Data source: Yahoo! Finance.

Until Powell began speaking in the afternoon, major market indexes were flat to slightly lower on the day. Yet even though what Powell said didn't really come as any big surprise to those who followed the relevant financial markets, it nevertheless seemed to give investors more confidence that their reading on the situation facing stock markets was correct.

That doesn't necessarily mean that the immediate future won't remain volatile, but it nevertheless led some to conclude that eventual victory over inflation and recessionary pressures was inevitable.

Federal Reserve building.

Federal Reserve building. Image source: Getty Images.

What Powell said

Powell continued to emphasize that there are two key components to Federal Reserve policy that some will find contradictory but that nevertheless apply. First and most important, the Fed is still concerned about the uncomfortably high level of inflation in the market.

That came at the beginning of Powell's speech, and the Fed chair emphasized that higher prices are causing substantial hardship for tens of millions of people across the nation. Such levels of price instability are fundamentally incompatible with a working economy, and current estimates of inflation, as measured by the Fed's preferred personal consumption expenditure metric, is coming in at 6%.

That left Powell to conclude that there's still a lot of work to do before inflation comes under control, let alone before it gets back to the 2% long-term target that the Fed prefers to see. Indeed, Powell warned that he believes the eventual level at which interest rates will rise sufficiently to get inflation under control will likely be higher than he thought at the time of the Federal Open Market Committee's meeting in September.

Yet at the same time, Powell acknowledged that using interest-rate increases to moderate inflationary pressures is an imprecise science. He also said there are definite lags between the time the central bank boosts rates and when the effects of tighter monetary policy actually show up in economic data, particularly concerning inflation.

Therefore, Powell said, "It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down." In addressing the timing of such moderation, the Fed chair said that a slowing of rate increases could come as soon as its December meeting.

Market watchers immediately took that comment to mean that the Fed would likely raise interest rates by just half a percentage point in December, slowing from the 0.75 percentage-point boosts that the central bank has made at its last four consecutive meetings. That, in turn, ignited the massive stock market rally, and longer-term interest rates also moved lower on the news, as bond investors foresaw a shorter period of time to fight inflation.

Not a shocker

Those watching the credit markets shouldn't have been surprised by what Powell said because it was already largely reflected in certain securities prices. As early as four weeks ago, federal funds rate futures showed that investors thought it more likely than not that the Fed would do a December increase of only half a percentage point.

Moreover, the short-term jump in stocks seemingly ignored the rest of Powell's monetary-policy comments. The chair repeated that restrictively high interest rates could be necessary for a significant period of time, and the central bank remains extremely wary of being premature in reversing course. Indeed, Powell pointed to several data points that remain worrisome, including above-normal wage growth, rising prices for housing services, and continued disruptions in labor markets that began with the COVID-19 pandemic.

Of course, it's possible that stock markets have overreacted in falling so far from their record levels in late 2021, so a reversal -- in light of things going mostly as expected -- is actually warranted. Regardless, investors need to be prepared for it to take more time than they might think for the Fed's inflation-fighting saga to play out to the bitter end.