Equities saw a steep decline on Friday after Federal Reserve Chairman Jerome Powell reiterated the central bank’s commitment to bringing down inflation by continuing to hike interest rates that could cause “some pain” to the U.S. economy.
At the long-standing annual Fed’s Jackson Hole Conference Friday, Powell said the bank will continue using its firepower “forcefully” to bring down the 4-decade-high inflation.
Powell Delivers a Strong Message
Even after implementing four consecutive aggressive interest rate hikes, Powell said it is not time yet to stop raising interest rates.
“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,” said Powell in his speech in Jackson Hole, Wyoming. “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
Equities fell sharply after the conference, with the Dow Jones (DJIA) losing more than 500 points. Powell’s speech comes just weeks after the latest consumer price index (CPI) print, which showed that inflation may have peaked as it eased to 8.5% in July from 9.1% in June. However, it is still early to conclude that consumer prices will continue declining.
The drop in CPI and personal consumption expenditures price (PCE) index came mostly due to a significant drop in energy prices, which have soared this year as coronavirus-induced lockdowns eased and after Russia’s invasion of Ukraine.
Meanwhile, the global economy is also experiencing a slowdown, with the housing sector facing particular headwinds. Furthermore, economists also expect the unprecedented hiring pace over the past year and a half to slow down.
Powell also said the Fed will focus on a broader period of data and continue combating inflation until it pushes it closer to its 2% long-term target. Looking ahead, Powell added that bringing back
“price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.”
The U.S. economy has now seen consecutive quarters of negative gross domestic product (GDP) growth, which was usually considered a sign of recession. But Powell and the other U.S. economists believe the underlying U.S. economy remains strong, even though it is slowing down.
Essentially, the central bank boss is attempting to say that it’s more important to fight inflation than spur growth at the moment, said LPL Financial’s head economist Jeffrey Roach.
During the speech, which was unusually short compared to previous years, Powell reiterated the importance of price stability and said it represents “the bedrock of our economy”.
“Without price stability, the economy does not work for anyone,” he added.
Investors are awaiting the Fed’s next Federal Open Market Committee (FOMC) in September to see if the central bank will implement a third consecutive 75 basis points rate hike. Powell said the size of the next rate increase hinges on the future economic data and the evolving outlook.
He said the bank will likely slow the pace of interest rate hikes at some point in the future as its monetary policy additionally tightens.
The market expectations are currently divided between a 50-bps and a 75-bps rate hike. Following Powell’s speech, the chances of another 75-bps increase stood at 54.5%, according to the CME Group’s FedWatch measure.
Another 75-bp rate hike in September would likely push the S&P 500 below the 4000 mark in response to the surging bond yields.
Powell also used historical data to support the Fed’s aggressive approach to combating inflation. He said the central bank’s failure to combat inflation forcefully in the 1970s led to an extended period of inflation, forcing the bank to introduce severe interest rate hikes in the early 1980s. Back then, the former Fed Chairman Paul Volcker had to tip the economy into recession to bring down prices.
U.S. equities fell sharply on Friday after Fed Chair Powell delivered a strong message that the central bank will do whatever it takes to tame decades-high inflation.