Jerome Powell, Federal Reserve Chair, told the Senate Banking Committee on Tuesday that additional rate hikes would be required to dampen the recent trend of rising inflation and persistently high job growth. Early Tuesday, the S&P 500 fell as the markets increased their odds that a rate hike of 50 basis points would occur on March 22.
Powell's testimony indicates that while Fed policy remains data-dependent it may take a weaker than expected jobs report this Friday or a CPI report the following week to limit the next rate hike to 25 basis point.
Powell stated that the incoming data and upward revisions of prior data "suggest that inflationary forces are running higher than anticipated" by Fed officials at their meeting in February. The Fed officials who met at the beginning of February were surprised by this. As a result "the final level of interest rate is likely to higher than anticipated."
Powell did not rule out a half-point rate hike for the next meeting. Powell stated that the Fed was "prepared" to accelerate rate increases if the "totality of data" warranted it.
On March 22, the Fed will also release its new quarterly projections. Powell's hawkish remarks suggest that the Fed could be planning a few more rate increases in the coming months. In December, the Fed's interest rate was projected to peak at between 5% and 5.25%.
The financial markets have experienced a dramatic shift in pricing since the February 3 January jobs report, which showed robust hiring and lower rates of unemployment. Markets had previously expected the Fed would hike rates less than its official projections, and start cutting rates by the end of this year. Before Powell's testimony the markets had just over 50% odds the Fed would raise its key rate by the September 19-20 meeting to a range between 5.5% and 5.75%. This implied two additional hikes in comparison to the Fed’s latest projections.
Odds that the rate will increase to 5.5%-5.5% after Powell's testimony reached 70%.
The odds of a 50 basis-point increase on March 22 increased from 30% to 48% after Powell's testimony. A strong jobs report and more firm inflation data could push the Fed towards a half-point increase.
The S&P 500 fell 0.7% on Tuesday morning after Powell's testimony.
The S&P 500 largely held steady over the last few weeks, despite rising Treasury yields and hot economic data. S&P 500 found support so far at its 50-day average. It staged a rally over that level on Saturday. A second test of the 50 day line may be on its way.
U.S. economic optimism reaches a 15-month high; investors feel fine, others not so much
The S&P 500 closed Monday 15.6% below the record high, but 13.2% above its October 12 bear-market low.
The yield on the 10-year Treasury note increased by one basis point to 3.995% on Tuesday.
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Two reasons may be driving the Fed to continue raising interest rates in the near future.
Fed officials are of the opinion that the costs associated with not raising rates enough to prevent inflation from becoming entrenched is much higher than the costs associated with hiking too high. Second, Fed officials have failed to convince the markets, up until fairly recently, that rates will move higher and remain there for a longer period of time. This had serious consequences. Treasury yields dropped, which helped lower borrowing costs and gave the economy a new wind.
Policymakers will not want to raise rates less than the markets expect now that markets finally listen to the Fed.
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