Federal Reserve Chairman Jerome Powell’s hawkish speech warned of economic “pain,” and markets, in the red across the board, are now pricing in another historic interest rate hike.
In a speech Friday in Jackson Hole, Wyoming, Powell said that the central bank will not stop jacking up interest rates to tame inflation, even though it may result in economic malaise and unemployment. The remarks had an immediate effect on the markets, sending stocks lower and Treasury yields higher.
The S&P 500 was down nearly 3% by Friday afternoon, while the tech-heavy Nasdaq composite was off more than 3.3%, and the Dow Jones Industrial Average was plunging by nearly 900 points.
The 10-year Treasury yield rose two hundredths of a percent to 3.032% while the 2-year rate was up by two hundredths of a percent to 3.392% following Powell’s speech.
INFLATION SLOWED IN JULY, ACCORDING TO A KEY GAUGE WATCHED BY THE FED
The anxiety was also captured by the VIX. The Chicago Board Options Exchange Volatility Index, better known as the VIX, is intended to gauge fear and uncertainty in the markets. The index was up more than 16% on Friday alone, an enormous jump that illustrates the concern that investors have with the rising rates and the possibility of a recession. It is up 50% since the start of the year.
During his speech, Powell predicted that the road to lower inflation would not prove to be an easy one and the economy would continue to take a hit while the central bank pushes interest rates ever higher.
“Reducing inflation is likely to require a sustained period of below-trend growth,” Powell said. “Moreover, there will very likely be some softening of labor market conditions. 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.”
In June, central bank officials announced that the Fed would raise its interest rate target by a whopping three-quarters of a percentage point. The Fed then conducted another 75-basis-point hike in July.
Powell said on Friday that “another unusually large increase” might be appropriate for the central bank’s meeting next month.
Inflation is now running at 8.5% in the 12 months ending in July, according to the consumer price index. That is down from a June peak of above 9%.
Powell’s speech raised the perceived odds of another monster 75-basis-point hike for investors.
The likelihood of such a hike occurring was pegged at more than 60% following the Jackson Hole speech, according to CME Group’s FedWatch tool, which calculates the probability using Fed fund futures contract prices. Just a day earlier, more investors were betting on a half-percentage-point increase, showing just how much Powell’s statements can change expectations.
The trade-off for lower inflation and higher interest rates, though, is slowing economic growth and possibly a recession, which some economists already think the United States is in. The U.S. has had two quarters of negative gross domestic product growth, with the economy contracting by 0.6% last quarter.
Nevertheless, the labor market has remained tight despite the negative growth, something that conflicts with the idea the economy is in recession. Powell warned Friday that it isn’t likely going to remain that way as the rate hikes continue to crack the economy.
Some economists don’t think the Fed is doing enough to tame the country’s worst inflation in four decades. The last time inflation was this bad, the Fed’s interest rate target was jacked up to more than 20% to squelch the explosive prices.
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Thomas Hogan, a senior research fellow at the American Institute for Economic Research, told the Washington Examiner that, judging by its actions rather than statements, the Fed has not made price stability its No. 1 priority, given how long inflation has been elevated.
“Powell said the FOMC plans to continue raising interest rates, but he reiterated their projection that the fed funds target will remain below 4% by the end of 2023. That hardly seems sufficient to address the highest rates of inflation in 40 years,” said Hogan.
