US stocks crashed yesterday and the Dow Jones turned negative for the year after Fed chair Jerome Powell spooked markets yet again with his hawkish comments during the Congressional testimony.
Powell said that interest rates would be higher than what the US central bank had previously anticipated. The December dot plot showed that FOMC members see rates rising to 5-5.25% by the end of 2023.
After the 25-basis point rate hike on February 1, the Fed raised interest rates to 4.50-4.75%, which is the highest since October 2007.
US inflation has been sticky
The headline CPI inflation peaked at 9.1% in June. It fell in every month since then which raised hopes that the Fed would take a more dovish stance. However, in January, US CPI rose by 6.4% YoY. While it was below the December reading of 6.5%, it was ahead of the 6.2% that analysts were expecting.
The CPI as well as wholesale inflation rose on a monthly basis in January. Some of the recent economic data has meanwhile been quite strong.
US retail sales also rose 3.1% in January. Also, in January, the US economy added 517,000 jobs which was over twice what the market was expecting. The strong economic data and sticky inflation show that the Fed has a long way ahead in reducing inflation to 2%.
Fed chair Powell spooks markets
Last month, referring to the January nonfarm payroll data, Powell said, that the jobs report was “certainly strong—stronger than anyone I know expected.”
He also said that a strong job market and wage growth make the job of lowering inflation tougher.
He reiterated similar comments in his testimony and said, “Although nominal wage gains have slowed somewhat in recent months, they remain above what is consistent with 2 percent inflation and current trends in productivity. Strong wage growth is good for workers but only if it is not eroded by inflation.”
Powell forecasts higher rates
In his prepared remarks for the Congressional testimony, Powell said, “The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.”
While Powell did not specify how higher the terminal rates would go, traders now see rates rising to 5.5%-5.75%. Also, the CME Fed Watch tool shows that traders now put an almost 75% probability of a 50 basis point rate hike in the Fed’s March meeting. A month ago, the probability was below 10%. However, the probability of a higher rate hike in March has been gradually rising after a flurry of strong economic data.
Notably, after Powell’s testimony, the odds of a 50 basis point rate hike in March went up from 31.4% to 74.9%.
Powell spooked markets with his comments
US stocks also fell yesterday on fears of higher rates. The Dow Jones fell 1.72% and turned negative for the year. The S&P 500 also lost 1.53% while the tech-heavy Nasdaq Composite fell 1.25%.
US stocks have whipsawed this year. In January, the Nasdaq had its best month in over two decades. However, since then, US stocks have looked weak.
In his remarks, Powell said, “Although inflation has been moderating in recent months, the process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy.”
He reiterated his previous stance and said that the Fed would be data-dependent. In his Congressional testimony, Powell said, “We will continue to make our decisions meeting by meeting, taking into account the totality of incoming data and their implications for the outlook for economic activity and inflation.”
Recession fears rise amid rising rates
Many economists fear that the Federal Reserve’s rate hikes would push the US economy into a recession. The minutes of the Fed’s December meeting acknowledged recession fears.
They stated, “the sluggish growth in real private domestic spending expected over the next year, a subdued global economic outlook, and persistently tight financial conditions were seen as tilting the risks to the downside around the baseline projection for real economic activity, and the staff still viewed the possibility of a recession sometime over the next year as a plausible alternative to the baseline.”
Powell is meanwhile still hopeful that the US economy can avert a recession and the US central bank can steer the world’s largest economy towards a soft landing.
Last year, Powell testified that while the Fed’s rate hike might push the US economy into a recession, the US central bank is not deliberately steering the economy towards a recession.
US stocks crashed in 2022
Federal Reserve’s rate hikes took a toll on US stock markets in 2022 and some analysts believe that 2023 would be no better. Hedge fund manager Dan Niles whose long-short fund outperformed the markets in 2022 sees US stocks hitting new lows in 2023.
Niles listed high inflation, rising interest rates, high inflation, and a slowdown in earnings as a bearish driver for US stocks.
Niles is not alone in predicting a new low for US stocks in 2023. Mike Wilson, Morgan Stanley’s chief US equity strategist, who correctly predicted the 2022 stock market crash, is not too bullish on the markets heading into 2023.
Powell says the Fed is ready to increase the pace of hikes
In his testimony, Powell said, “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”
Notably, the Fed started with a 25-basis point rate hike in March 2022 and raised rates by 50 basis points in the next meeting. It was followed by four consecutive rate hikes of 75 basis points. In December, Powell announced a 50 basis point rate hike and the Fed further slowed the pace to 25 basis points in the next meeting.
After Powell’s statement, markets now brace for an increase in the pace of hikes in the next Fed meeting which is scheduled later this month.
Markets brace for higher rates
Chris Rupkey, chief economist of FwdBond said, “Powell hit the market right between the eyes saying if the economy is flying high and moving faster this year, then monetary policy will have to follow with faster and higher rates if they are going to have any chance at bringing inflation down.”
He added, “The market heard the word faster and that was all they needed to price in a greater chance of a [50 basis point, or half-point] rate hike in two weeks.”
Meanwhile, after the slump yesterday, US stock futures are flat today. The next key trigger for the markets this week would be the February inflation data.
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