Jerome Powell is the Federal Reserve Chairperson, given the role by former President Donald Trump and kept on by current President Joseph Biden. When he was first nominated, many complained at his lack of academic qualifications (Powell comes from the banking, rather than the university, world, unlike most of his predecessors) and worried that he would make mistakes.
Whether he has or not is a complicated and controversial issue, but no one can deny he has had an incredibly tumultuous period to manage. Even before the pandemic, Powell was facing severe criticism and radical changes to monetary policy, international trade agreements, and taxation rules that simply caused previous models to no longer work. And, for the most part, among professionals (that is, academic economists and financiers at the top banks), Powell has earned the respect of people who have analyzed his moves and seen in them competence, if not brilliance.
Just about every Fed chairperson gets harsh criticism, but what is interesting about them all is that they have tremendous power—at least, when it comes to the equity and debt markets. Also, arguably the Fed’s ability to control monetary policy also has widespread implications for politics, culture, and life in general—but the line between the Fed and those things is by no means straight.
So, when we want to see the power of the Fed, it’s usually when the Fed chairperson speaks. And Jerome Powell’s speech at Jackson Hole last week was both typical and very unusual. These annual policy speeches given at Jackson Hole (a historically significant place for monetary policy, it should be noted) are now an important market moment for the world, so Powell’s speech was widely anticipated, talked about, and predicted in various markets.
But most of the predictions were wrong. Powell’s speech was incredibly hawkish, saying that there is “no place to stop or pause” interest rate hikes, adding that higher interest rates are necessary and will last for longer than many expect. “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” he said—and markets immediately plummeted, with tech stocks losing over 3% in hours afterwards.
This facet of financial markets might surprise finance students, who study the numbers part of finance. Numbers are important, but in most cases and for most market participants the math is pretty basic: a lot of algebra, ratios, and some simple statistics are what most financiers deal with in their everyday work. But what really impacts markets and changes the entire mood of the stock or bond markets are words: when Powell uses words like “some pain,” it is a shock to markets.
Why the shock? For one reason, “some pain” is code word for “recession” or, at the very least, a decline in economic growth. The market saw that Powell is admitting he will throw the economy into recession if needed to tame inflation. This inspired backlash, including the economics-trained Elizabeth Warren, who told CNN she fears “the Fed is going to tip this economy into recession.”
There’s more behind the shock, however. “Some pain” is very strong language for a Fed chairman—not something one often hears, and those outlying statements are what traders and investors live for. In fact, some hedge funds and alternative asset managers have created tools that automatically analyze the language of speeches like this to make instant trades after the fact. Far from math, this is a linguistic analysis used to make money.
And this isn’t where the linguistics in finance ends. Equity analysts carefully monitor the words of management at public events and earnings calls. Sales/traders listen to what clients and other traders say to try to get a sense of market sentiment. And even bond ratings firms will interview customers of a company to see how they feel about that firm—and those feelings become part of the bond ratings.
Finance isn’t all numbers, although those numbers are essential. The real powerful force behind finance is words.
