The Dow Jones Industrial Average lost some value early in the week after a hawkish speech by the Fed’s chair, but by the closing bell on Friday the index managed to edge out a mild gain of 107 points. The S&P 500 and Nasdaq also netted gains for the week by 80 points and 276 points respectively.
Speaking to the National Association for Business Economics on Monday, Federal Reserve Chair Jerome Powell said that “inflation is much too high” and that “there is an obvious need to move expeditiously to return the stance of monetary policy to a more neutral level, and then to move to more restrictive levels if that is what is required to restore price stability.”
While the Fed already raised its interest rates to the 0.25% to 0.5% range, there is little doubt the central bank will go much higher than that by the end of the year.
“If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so,” Powell said.
In an attempt to deflect criticism of its previously dovish stance, Powell added that “forecasters widely underestimated the severity and persistence of supply-side frictions, which, when combined with strong demand, especially for durable goods, produced surprisingly high inflation.”
He added that “many forecasters” had expected inflation to cool in the second half of 2021 as vaccines took hold, schools reopened, and supply-side bottlenecks were solved. “While schools are open, none of the other expectations has been fully met,” Powell said. “It continues to seem likely that hoped-for supply-side healing will come over time as the world ultimately settles into some new normal, but the timing and scope of that relief are highly uncertain.”
Given that backdrop, investors now are pricing in an additional 180 basis points — or an extra 1.8% — increase in interest rates this year. With six additional meetings by the Federal Open Market Committee to come, that means Wall Street expects at least one 0.5% increase in interest rates during one of those meetings. Perhaps more than one, with some analysts predicting the Fed will raise rates by 50 basis points at both its May and June meetings.
Some worry the Fed’s newfound aggression could significantly restrain the economy. Paul Ashworth, chief North America economist at Capital Economics, wrote on Friday that “concerns are also mounting that front-loading so much monetary tightening into this year could weaken real GDP growth, and possibly even tip the economy into recession.”
Ashworth noted that the three-year yield curve for ten-year Treasuries points to only a 5% chance of a recession, and that his forecasts predict the yield on those bonds will hit 3% by the end of 2023. On Friday, yields hit their highest point in two years, beginning Friday at 2.475%.
But with no Fed meeting for another six weeks, in the short term, investors are laser-focused on commodity prices, says Tom Essaye of the Sevens Report.
“Unlike the Fed, where the impacts won’t be felt for months or quarters, the impact of commodity prices is right now and the longer they stay elevated, the stronger the headwind on growth,” he wrote to investors Friday morning.
The price of oil has remained elevated and saw a spike on Wednesday, with barrels of crude on the West Texas Intermediate hitting $113 by late Friday. But with no end in sight to the Ukraine crisis, oil is likely to remain high.
“Inflation remains enemy #1 and every day Russia continues to keep Putin in power equals another day of higher commodity prices,” wrote James Vogt of Tower Bridge Advisors. “As inflation stays elevated for much longer than many expected, the Fed will react even more aggressively.”
Vogt noted the central bank will need to unload its $9 trillion in assets more aggressively to help combat inflation, but that the cost of fuel is not likely to drop significantly any time soon.
“A gradually slowing global economy will help some, but not nearly enough to quell the commodity spikes, which are turning into the new norm as opposed to coming back to earth,” he said.
The cumulative effects of inflation, the war in Ukraine and interest rates have continued to weigh on consumers. The University of Michigan’s monthly index on consumer sentiment found the index again dropped, this time to 59.4 from 62.8 in February. The survey also found that expected inflation is the highest it has been since 1981, with expected gas prices saw their largest monthly increase in decades.
The survey is down 30% from March 2021, and many survey respondents mentioned reduced living standards, more so than in any other period except during the recession of 1979 to 1981 and during the Great Recession of 2008.
“Just when difficult decisions need to be made about monetary and fiscal policies, consumers have expressed loss in confidence in government economic policies,” said Richard Curtin, the survey’s chief economist. “While consumer solidarity about policy choices is unrealistic, the widespread partisan divisions may stifle policy compromises and promote less favorable outcomes for all.”