Fed Chair Powell’s comments rattle Senate/stock market
On Tuesday and Wednesday, Federal Reserve Chair Jerome Powell delivered his semi-annual testimony before the Senate Banking Committee. The discussion quickly turned to the Fed’s ongoing efforts to get inflation back to its 2% target rate. Though the Fed didn’t create our current inflationary environment, as part of its mandate, it’s tasked with the responsibility of trying to get inflation back under control.
So far, the Fed’s primary tool in trying to dampen inflation has been raising the benchmark fed funds rate. By raising interest rates, the Fed hopes to reduce consumer spending and thus tap the brakes on rising consumer prices. Since March 2022, the fed funds rate has been raised from near-0% to its current level between 4.5%-4.75%. This has been the most aggressive pace of interest rate hikes in more than 40 years. For you Federal Reserve history buffs, in March 1980, then-Fed Chair Paul Volcker raised the fed funds rate from 15% to 20% in just a single month to help quell an inflation rate of 14.8%.
Inflation has fallen from its June peak of 9.1% to its current pace of 6.4%. But remember, the end goal is 2%. Any inflation above 2% is deemed excessive and inflicts undue pain on consumers, businesses and the economy. But on Tuesday, Powell noted that “The process of getting inflation back down to 2% has a long way to go and is likely to be bumpy”. The rather somber outlook created a bit of a verbal firestorm among some members of the Senate Banking Committee who challenged the Fed’s methods in combating this stubbornly high inflation.
Powell’s comments also triggered a 1.7%, 575-point sell-off in the Dow Jones Industrial Average on Tuesday. Prior to his appearance at the Senate Banking Committee, many on Wall Street expected the Fed to raise the fed funds rate by 0.25% at its March 22 meeting and by another 0.25% at the following May 3 meeting. This would take the fed funds rate to a range between 5%-5.25%. Wall Street hoped the Fed would then be finished raising interest rates.
But Powell further stated that the latest economic data suggests that even more rate hikes could be warranted and that these future rate hikes could now come at a much faster pace. Some Wall Street analysts now contend the fed funds rate could be raised to as high as 6%, the highest level since January 2001.
Much of the heated rhetoric during Powell’s testimony centered on the fallout to the U.S. economy. The higher that interest rates are pushed, the greater the odds of recession and the greater the potential impact to the labor market. The national unemployment rate currently stands at 3.6%. However, that rate is expected to rise to 4.5%-5% by year-end. For every 1% rise in the unemployment rate – such as rising from 3.6% to 4.6% – translates to about 1.6 million workers losing their job. If the unemployment rate were to instead rise to 6%, or even higher, several million additional workers could be affected.
Powell admits that the Fed’s interest rate hikes will “very likely” impact the U.S. labor market. So, why would the Fed even go down that road? Why would it even risk putting the labor market in jeopardy?
Powell argues that any pain inflicted on the U.S. labor market – as well as on the broader economy – would be much more severe if the Fed were less aggressive in trying to tame inflation. For the past two years, Americans have faced a continued barrage of surging consumer prices, especially in basic necessities. In January, 92% of the monthly rise in inflation was caused by the rising cost of food, shelter and energy. Since February 2021, food prices have increased by 18%, the cost of shelter has increased by 12% and energy prices have risen a massive 33%. In the Fed’s eyes, such a detrimental impact to the American consumer is simply not sustainable.
Mark M. Grywacheski, Investment Advisor
Quad Cities Investment Group is a Registered Investment Adviser.
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