The Fed’s Powell triggered a 1,000-point rout in the Dow. Here’s what investors should do next.

Now may be the time to consider hiding in short-dated government bonds or corporate bonds and other defensive parts of the stock market.

On Friday, central bank chief Jerome Powell spoke of a will to inflict “some pain” on households and businesses in an unusually blunt Jackson Hole speech that hinted at a 1970s-style inflation debacle unless the central bank can rein in the seething price gains that are approaching four-decade highs.

Read: Fed’s Powell says bringing down inflation will cause pain for households and businesses in Jackson Hole speech

Powell’s sharp stance had strategists searching for the best possible plays for investors to make, which could include Treasuries, energy and financial stocks and emerging market assets.

The Fed chair̵[ads1]7;s willingness to essentially break parts of the U.S. economy to curb inflation “obviously hurts the front end” of the financial market, where interest rates are moving higher on expectations of Fed rate hikes, said Daniel Tenengauzer, head of market strategy for BNY Mellon in New York.

To his point, the 2-year Treasury yield TMUBMUSD02Y,
hit its highest level since June 14 on Friday, at 3.391%, following Powell’s speech — reaching a level last seen when the S&P 500 officially entered a bear market.

Investors may consider playing the front end of credit markets, such as commercial paper and leveraged loans, which are floating-rate instruments — all of which take advantage of the “clearest direction in the markets right now,” Tenengauzer said by phone. He also sees demand for Latin American currencies and stocks, given that central banks in that region are further along in rate-hike cycles than the Fed, and inflation is already starting to ease in countries like Brazil.

A Fed battle cry

Powell’s speech was a moment reminiscent of Mario Draghi’s “do whatever” rallying cry a decade ago, when he pledged as then president of the European Central Bank to preserve the euro during a full-blown sovereign debt crisis in his region.

Attention now turns to next Friday’s nonfarm payrolls report for August, which economists expect will show a job gain of 325,000 after July’s unexpectedly red-hot 528,000 reading. Any wage gain above 250,000 in August would add to the Fed’s case for further aggressive rate hikes, and even a gain of 150,000 would be enough to generally keep rate hikes going, economists and investors said.

The labor market remains “out of balance” – in Powell’s words – with demand for workers outstripping supply. August’s jobs data will give a glimpse of how bad things could still be, which will reinforce the Fed’s No. 1 goal of getting inflation down to 2%. Meanwhile, continued rate hikes risk tipping the U.S. economy into recession and weakening the labor market, while limiting the time Fed officials can have to act forcefully, some say.

“It’s a very delicate balance and they’re operating in a window now because the labor market is strong and it’s pretty clear they should push as hard as they can” when it comes to higher interest rates, said Brendan Murphy, North American head. of global interest for Insight Investment, which manages $881 billion in assets.

“All things being equal, a strong labor market means they have to push harder, given the context of higher wages,” Murphy said by phone. “If the labor market starts to deteriorate, the two parts of the Fed’s mandate will be at odds, and it will be more difficult to increase aggressively if the labor market weakens.”

Insight Investment has been underweight duration in bonds in the US and other developed markets for some time, he said. The London-based firm also takes on less interest rate exposure, stays in flattening trades, and selectively overweights European inflation markets, particularly Germany’s.

For Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York, the best mix of plays for investors to take in response to Powell’s Jackson Hole speech “is to be on the offensive in materials/energy/banks/select EM and defense in dividend/low volume stocks (think healthcare)/long dollar.”

‘Preliminary signs’

The depth of the Fed’s commitment to stand by its anti-inflation campaign sank in on Friday: Dow industrials DJIA,
sold 1,008.38 points for its biggest decline since May, leaving it along with the S&P 500 SPX,
and Nasdaq Composite COMP,
nursing weekly losses. The Treasury curve inverted deeper, to as little as minus 41.4 basis points, as the 2-year yield rose to nearly 3.4% and the 10-year yield TMUBMUSD10Y,
was little changed at 3.03%.

For now, both the inflation and employment sides of the Fed’s dual mandate point toward tighter policy, according to Capital Economics senior U.S. economist Michael Pearce. However, there are “preliminary signs” that the US labor market is starting to weaken, such as an increase in jobless claims compared to three and four months ago, he wrote in an email to MarketWatch. Policymakers “want to see the labor market weaken to help bring wage growth down to rates more consistent with the 2% inflation target, but not so much as to generate a deep recession.”

With the unemployment rate at 3.5% in July, one of the lowest levels since the late 1960s, Fed officials still appear to have plenty of room to press ahead with the inflation battle. Indeed, Powell said the central bank’s “overarching” goal is to bring inflation back to the 2% target, and that policymakers will stand by that task until it’s done. In addition, he said they will use their tools “vigorously” to achieve that, and failure to restore price stability will mean more pain.

Hikes with front feeding

The idea that policymakers might be “wise” to front-load rate hikes while they still can appears to be what motivates Fed officials like Neel Kashkari of the Minneapolis Fed and James Bullard of the St. Louis Fed, according to economist Derek Tang at Monetary Policy Analytics in Washington.

On Thursday, Bullard told CNBC that with the labor market strong, “it seems like a good time to get to the right neighborhood for the funds rate.” Kashkari, a former dove who is now one of the Fed’s top hawks, said two days earlier that the central bank must push for tighter policy until inflation is clearly moving down.

Luke Tilley, the Philadelphia-based chief economist for Wilmington Trust Investment Advisors, said the next non-farm payrolls report could come in either “high or low” and that it still would not be the main factor behind Fed officials’ decision on the size of the interest rate . hiking.

What really matters to the Fed is whether the labor market shows signs of loosening from the current tight conditions, Tilley said by phone. “The Fed would be perfectly fine with strong job growth as long as it means less pressure on wages, and what they want is not to have such a mismatch between supply and demand. Hiring isn’t the big deal, it’s the fact that there are so many vacancies for people. What they really want to see is a mix of weaker demand for labour, a decline in vacancies, stronger labor force participation and less pressure on wages.”

The week ahead

Friday’s August jobs report is the data highlight for the coming week. There are no major data releases on Monday. Tuesday brings the S&P Case-Shiller housing price index for June, the consumer confidence index for August, July data on job vacancies plus exits, and a speech by New York Fed President John Williams.

On Wednesday, Loretta Mester of the Cleveland Fed and Raphael Bostic of the Atlanta Fed will speak; The Chicago Manufacturing Purchasing Managers index has also been released. The following day, weekly initial jobless claims, the S&P Global US Manufacturing PMI, the ISM manufacturing index and July construction spending data are released, along with more comments from Bostic. Friday, July factory orders and a revision of core capital equipment orders are released.

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