Stock markets are tanking the day after the Federal Reserve delivered their biggest rate increase in nearly 40 years, aimed squarely at tackling ever hotter U.S. inflation.
The Federal Open Market Committee (FOMC) raised the federal funds rate by 75 basis points (bps), the biggest single increase since November 1994. This historic decision boosted the fed funds to a range of 1.5% to 1.75%.
As of midday, the S&P 500 is down 2.8%, the Dow Jones Industrial Average (DJIA) is off approximately 2.0%, while the tech-heavy Nasdaq Composite is down nearly 3.7%.
Treasury yields climbed rapidly after the decision, although they’re off their highest levels as of midday. The 2-year yield is at 3.18% and the benchmark 10-year yield is above 3.34%.
The Fed Gets Serious on Inflation
Expectations for a bigger Fed rate hike had risen dramatically ahead of yesterday’s decision. Coming into June, the overwhelming bet was that the Fed would offer another 50 bps rate hike, in line with Fed Chair Powell’s comments at the March meeting.
Then the May Consumer Price Index (CPI) report dashed hopes that inflation was moderating. The data indicated that inflation unexpectedly accelerated in May, rising 8.6% year-over-year, the most since 1981. A subdued April CPI print had raised hopes that price increases were cooling off.
Seemingly overnight, market expectations immediately started pricing in a 75 bps increase as most likely, and the Fed did not disappoint. While analysts welcomed the bigger move as as sign that the Fed is finally getting serious about inflation, the real fear is that the central bank has let the problem get hopelessly out of control.
“The tragic error of the last year was not moving rates sooner to create more breathing space for future meetings,” says Brad Conger, deputy CIO of Hirtle Callaghan & Co. “The FOMC is now boxed in to responding reflexively to inflation data. The terminal Fed Funds remains the same at 3.80%.”
An updated Summary of Economic Projections (SEP) was fuel for the fire, as Fed officials trimmed their outlook for 2022 gross domestic product (GDP) to +1.7% from the +2.8% forecast in March. For 2023, Fed officials see +1.7% GDP, down from +2.2% in March.
At the post-decision press conference, Powell insisted that “…the economy is well positioned to handle tighter policy.” Markets are less sure of that.
“If inflation continues to surprise to the upside they are likely to tighten more than they currently think is appropriate,” says Bill Adams, chief economist for Comerica Bank. “On the other hand, if the economy’s current slowdown turns into an outright recession, potentially including a decline in house prices, the Fed could hike less than expected or start cutting interest rates earlier than they expect.”
Rate Hikes Will Continue Until Morale Improves
Stock markets are prone to manic depressive shifts, switching rapidly from unwarranted optimism to excessive pessimism in just one or two trading sessions. That’s certainly behind the moves of the last 24 hours.
Markets rallied in the immediate aftermath of the decision on Wednesday, closing out the session with a solid gain. But the selling returned with a vengeance this morning.
The next Federal Open Market Committee (FOMC) meeting is scheduled for July 26-27, and markets are pricing in a 88.5% chance of another 75 bps rate hike, which would put the target rate for federal funds between 2.25% and 2.5%.