It just keeps getting bleaker on Wall Street.
A day after the Federal Reserve imposed its biggest rate increase in 28 years, US stocks tumbled on Thursday, as investors came to grips with the growing possibility that the central bank’s aggressive anti-inflation campaign could tip the economy into a recession.
The Fed has boosted its benchmark federal funds rate three times since March, for a total of 1.5 percentage points, and has said it will continue increasing the rate until inflation retreats.
Higher fed funds rates flow through to consumers and businesses in the form of steeper borrowing costs. The average rate on a 30-year mortgage reached 5.78 percent this week, mortgage buyer Freddie Mac said on Thursday. The rate was below 3 percent as recently as mid-November.
Fed officials are aiming to reduce spending and investment, thus relieving pressure on prices. The fear is that consumers pull back too far, triggering an economic downturn and rising unemployment. The US housing market is showing hints of a slowdown. In Canada, where inflation is also high and the central bank is tightening credit, home prices are already falling.
“Inflation is the number one concern of the Fed, and until that comes down volatility across markets is likely to remain the status quo,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management in Boston.
Thursday’s selloff left the Standard & Poor’s 500 index at its lowest level since December 2020. The bellwether index fell 3.25 percent on the day, while the Dow Jones industrial average shed 2.4 percent to end below 30,000 for the first time since January 2021. The Nasdaq, filled with tech stocks that typically fare worse when interest rates rise, dropped 4.1 percent, and languishes 34 percent below its November peak.
Stocks had rallied on Wednesday afternoon after the Fed boosted its primary lending rate by three-quarters of a percentage point. Investors seemed relieved that officials were escalating their efforts to wrestle inflation to the ground after being slow to acknowledge the seriousness of the problem.
But stocks fell sharply overnight in Asia and Europe, and the US market opened lower Thursday, quickly giving up the previous day’s gains and much more.
Why the change in sentiment?
What went down on Wednesday was. . .unusual.
Fed officials had signaled repeatedly that when they met this week they would boost rates by one-half point.
But last Friday, the outlook for inflation got worse, with the Labor Department reporting that consumer prices in May rose 8.6 percent from a year earlier, the biggest year-over-year increase since 1981. Then, two widely followed monthly surveys showed consumers anticipated inflation elevated for the next one- and five-year periods.
Wednesday arrived with true uncertainty over what the Fed would do.
“This is an unusual situation to get, you know, some data ... pretty close, very close to our meeting; very unusual, one that would actually change the outcome,” Fed chairman Jerome Powell said during a post-meeting news conference.
Officials went with the bigger rate hike, with Powell saying “bold action” was called for. He also said, “I do not expect moves of this size to be common.”
Investors’ initial reaction was something like, “Phew, at least we know what to expect.”
Then Wall Street slept on it.
There was a lot of information for investors to digest Wednesday after the market closed: Powell’s news conference comments, new quarterly forecasts from members of the rate-setting Federal Open Market Committee, and a subtle but very meaningful shift in the language of the Fed’s statement.
- Powell: While the economy is strong and can absorb higher borrowing costs, achieving a “soft landing” — returning to the Fed’s preferred inflation rate without inducing a recession — has been made much tougher by variables beyond its control. Those factors include the war in Ukraine, which has accelerated already-troubling increases in energy and food prices, and pandemic-related contortions in the supply and demand of some goods and services.
- FOMC forecasts: Economic growth will slow dramatically this year, to a median projection of 1.7 percent in 2022 from 5.7 percent last year. Inflation will come down, but it won’t get close to the Fed’s 2 percent target until 2024. Yet, surprisingly, the Fed projections called for only a modest tick up in the jobless rate, to 3.9 percent in 2023 from a near-record low of 3.6 percent last month. Some economists said it was unrealistic to expect unemployment to remain that low with interest rates climbing and the economy shifting into low gear.
- The Fed statement: Following its last meeting, in May, the central bank’s policy statement said, “The Committee expects inflation to return to its 2 percent objective and the labor market to remain strong.” That line was gone this time, replaced with, “The Committee is strongly committed to returning inflation to its 2 percent objective.” To Fed watchers, the change indicated that officials were growing less confident about their ability to rein in inflation without damaging the job market.
Good morning. Sell, sell, sell.
The Fed has a dual mandate: Maintain price stability while promoting maximum employment. Powell’s message on Wednesday was that to support the labor market, inflation must be reduced. He insisted that the Fed wasn’t trying to engineer a recession to beat back rising consumer prices, but investors’ belated takeaway was that a downturn may be the price of fixing inflation.
“Investors are digesting the fact that the Fed is going to do its best to fight inflation,” said Eric Merlis, head of global markets trading at Citizens Bank in Boston. “However, that has ramifications for economic growth and corporate earnings.”