Stocks sank on Tuesday after the head of the Federal Reserve warned that he may turn the dial back on raising interest rates if inflationary pressures remain high. The warning rattled markets and raised fears of a possible recession in the future.
The S&P 500 fell 1.5% for one of its worst days of the year so far. The Dow Jones Industrial Average lost 574 points, or 1.7%, while the Nasdaq composite fell 1.2%.
Inflation and what the Fed is doing about it has been at the center of Wall Street’s swings this year. After appearing to be in steady decline since last summer, last month’s inflation reports were surprisingly hot. As well as a range of other data about the economy.
That raised concerns that inflation remained stronger than expected and that the Fed would have to raise rates higher than previously thought. Higher interest rates can reduce inflation because they slow the economy, but they affect stock prices and other investments. They also increase the risk of recession later.
Fed Chairman Jerome Powell on Tuesday confirmed some of those fears and said the latest data meant “the final level of interest rates is likely to be higher than previously expected.” He also said in testimony before a Senate committee that the Federal Reserve is ready to increase the pace of its hikes again if necessary.
That would be a sharp reversal after it had just slowed its pace of hikes to 0.25 percentage points last month from earlier hikes of 0.50 and 0.75 points.
“If the body of data shows that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” Powell said. “Restoring price stability will likely require us to maintain a restrictive monetary policy stance for some time.”
After remaining largely unchanged just before Powell’s testimony, stocks fell immediately afterward.
“This is the market coming back to realistic expectations,” said Megan Horneman, chief investment officer at Verdence Capital Advisors. “I think it will continue to wash some of the excess out of the market.”
Wall Street had already begun to be convinced that higher rates were on the cards than previously thought, and that the Fed may even return to larger rate hikes after last month’s data reports.
Since receiving last month’s job blowout report and other surprisingly strong data, Wall Street has largely abandoned hopes that permeated earlier this year for a possible rate cut later in 2023. It also raised its forecast about how high the Fed will eventually take interest rates before pausing.
That was clearest in the bond market, where the yield on the 10-year Treasury note topped 4% last week and hit its highest level since November. It helps determine interest rates for mortgages and other important loans.
It edged back to 4% on Tuesday after Powell’s comments, before falling back to 3.97% from 3.96% late Monday.
The yield on two-year Treasuries, which has been beating expectations for the Fed, jumped to 5.01 percent from 4.87 percent and was at its highest level since 2007.
Traders now see a better two-in-three chance that the Fed will accelerate rate hikes and raise them by 0.50 percentage points on March 22. That’s a flip-flop from a day earlier, when the widely held bet was for the Fed to stick with a smaller hike of 0.25 points, according to CME Group data.
“If they went to 75 after going back to 25, that would spook the markets,” Horneman said. “I still think they’re going to go to 25, but if they go to 50, I think that” would be seen as “a lot of flexibility for the Fed and it can act quickly if necessary if the economic data tells them that.”
“If they articulate it, I think the markets can accept it.”
More fireworks could arrive later this week and next as the Fed receives more data points to help shape its decision-making ahead of its next meeting on interest rates.
The US government’s monthly jobs report will be released on Friday. Within this, most of the focus will be on how high workers’ wages are. The fear at the Fed is that earnings that are too strong could put more pressure on inflation.
Two reports next week will then provide updates on how high inflation remains at both the consumer and wholesale levels.
The challenge for the market was that the economy was actually too strong despite all the rate hikes the Fed threw at it. While this resilience allays concerns that a recession could be imminent, it likely means that rates will have to stay higher for longer. This, in turn, raises the risk of a deeper recession in the future.
Big swings among investors about where inflation and the Fed are heading have sent markets tumbling. In January, stocks rose and bond yields fell on hopes that inflation would cool and lead the Federal Reserve to ease interest rates. Then last month’s flurry of strong data shattered those expectations and sent stocks tumbling and bond yields soaring.
Overall, the S&P 500 fell 62.05 points on Tuesday to 3,986.37. The Dow lost 574.98 to 32,856.46 and the Nasdaq sank 145.40 to 11,530.33.
One of them is WW International, better known as WeightWatchers. It jumped 79.1% after it said it was entering the prescription weight loss business with the purchase of telehealth platform Sequence.
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AP business writers Yuri Kageyama and Matt Ott contributed.
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