Federal Reserve chief Jerome Powell on Monday responded to the legion of economists casting doubt on policymakers' Goldilocks forecast issued last week. But his rebuttal appears only to have left investors bracing for more aggressive tightening. After the release of Powell's speech, the Dow Jones Industrial Average slipped further, while the Nasdaq reversed lower.
Powell essentially delivered two messages that some might see as contradictory. First, contrary to conventional wisdom, Fed rate hikes haven't led to recession every time, except for the 1994 tightening, he said. Second, the Fed is prepared to tighten much more aggressively than it indicated last week.
Shortly after the speech transcript was released, at around 12:30 p.m. ET, Treasury yields spiked. The 10-year yield surged 14 basis points to 2.29%, its highest point since May 2019. Now markets are pricing-in about 62% odds of a half-point rate hike on May 4, up from 44% on Friday, according to CME Group's FedWatch page.
"If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so," Powell said.
Powell's latest speech seemed to underscore what some economists had already concluded. The seven rate hikes penciled in for 2022 at last week's meeting were "merely a floor," not a base case, Jefferies chief U.S. financial economist Aneta Markowska wrote Friday.
Dow Jones Slips After Powell Rally
The Dow Jones pared its loss to 0.65% just before the close, snapping a four-day advance. The S&P 500 narrowed losses to 0.1%, while the Nasdaq shed 0.5%.
A stock market pullback isn't surprising after last week's rally. The Dow recorded its biggest weekly gain since Nov. 6, 2020, rising 5.5%. The Nasdaq scored a 10.4% move over four days.
Powell's Wednesday news conference provided the spark. He expressed optimism that the Fed could rein in inflation without derailing growth. He and others seek a policy that's not too hot or too cold, deemed the Goldilocks approach.
Powell's comments Monday threw cold water on a rally that he probably did not intend to ignite in the first place. It's unlikely that the Fed chief would intentionally aim to send stock prices lower. But a weaker market does play into the Fed's aim to "moderate demand growth."
"The strong financial position of households," Powell said, is a contributor to lower labor force participation that's fueling wage growth. Powell said the Fed could finalize its plan to begin paring its balance sheet at the next meeting.
Experts generally see fed asset purchases as a positive for stock prices. Fed buying of low-risk government securities holds down interest rates, thus encouraging risk-taking and underpinning stock valuations. The reverse process, dubbed quantitative tightening, is therefore a headwind for the stock market. How strong a headwind, of course, is hard to say.
Is Federal Reserve Recession A Risk?
The Fed has only just begun hiking its key rate from near zero. An even faster pace of rate hikes should still leave monetary policy quite loose for some time. The risk to the economy would come if rate hikes aren't slowing the economy enough to lower the threat of too-high inflation.
The Fed's quarterly projections saw growth moderating to 2.8% this year and 2.2% next — still moderately above what the Fed considers the economy's long-term trend. Unemployment is seen falling to 3.5% this year and holding there. Yet the Fed's primary inflation-rate indicator is seen easing to 4.3% this year and 2.7% next.
To numerous economists, it seems unlikely that the Fed can rein in inflation without pushing up unemployment. Some cite the data point that Powell took issue with, a nearly perfect record of Fed tightening producing a recession.
Exceptions To Soft Landings
Powell noted 1965, 1984 and 1994 as exceptions that delivered soft or "soft-ish" landings. He also cited the 2015 to 2019 Federal Reserve tightening, which preceded recession, but the recession because of Covid, not the Fed.
Yet none of those examples offers much reason for optimism. The first, 1965, was at the beginning of the inflationary guns-and-butter era, hardly an example for today's policymakers to follow.
Both 1965 and 1994 came after deep recessions, when unemployment was still elevated. The 2015-19 period saw inflation running below target, so it was easy for the Fed to reverse course when the economy weakened.
The current situation, with the labor market tight to an "unhealthy" extent and inflation at a 40-year high, offers a completely different challenge. Powell and the Fed need to catch a break for this to work out. There is a chance that they may.
But so far, the Covid spikes and Russia's invasion of Ukraine keep making the job harder.
Please follow Jed Graham on Twitter @IBD_JGraham for coverage of economic policy and financial markets.
