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Wednesday, May 22, 2024 | Back issues
Courthouse News Service Courthouse News Service

Wall Street dips as Fed’s new aggression takes hold

Investors are starting to accept that the Federal Reserve is not kidding when it says it will take a faster approach to quantitative easing than it has in previous years.

MANHATTAN (CN) — The Federal Reserve is trying to dispel any notion that it is bluffing in its newfound hawkish approach, and Wall Street is beginning to pull back.

Beginning the week with losses, all three indices shed points from last week as the central bank and its members have been beating the drum for a more hawkish approach to interest rates and its balance sheet. By the closing bell on Friday, the Dow Jones Industrial Average lost 95 points, the S&P 500 declined 57 points, and the Nasdaq fell 550 points.

On Wednesday, the Federal Open Markets Committee released its minutes from the central bank’s March meeting, during which officials said it would reduce its balance sheet of Treasury securities and mortgage-backed securities by $95 billion. Those reductions likely would be phased in over a period of three months starting in May, though participants said it could take longer.

The Fed noted that its current balance sheet runoff would be faster than the decline in securities holdings that took place from 2017 to 2019, with a few participants noting the Fed could hold some Treasuries if the central bank wanted to keep its portfolio neutral. Currently the Fed has about $9 trillion in the assets on its books.

The Fed, which has already raised interest rates by 0.25% last month, noted it would remain aggressive on interest rate hikes, motivated in part by the current geopolitical pressures.

“Various participants also noted downside risks to the outlook, including risks from the Russian invasion of Ukraine, a broad tightening in global financial conditions, and a prolonged rise in energy prices,” the minutes state. “Several participants judged the upside risk to inflation associated with Ukraine war appeared more significant than the downside risk to growth.”

While many analysts are saying “I told you so” to the Fed, some say the central bank is currently on the right track.

“Yes, this is partially their fault since they kept expanding the balance sheet up through February, but they have turned 180 degrees,” wrote James Vogt of Tower Bridge Advisors, pointing to the recent Treasury yield curve as proof of the pudding. “That could be a sign that Fed actions will work and some of the more negative outcomes can be taken off the table.”

Others are not so sure the Fed can climb out of the morass of its own making.

“Now the Fed has lurched from one extreme to the other,” Paul Ashworth, chief North America economist at Capital Economics, wrote in an investor’s note. He expects a 1.5% interest rate increase over the next three meetings, and, by the time of the third rate hike, “it should be obvious” to the Fed that gross domestic product growth is below potential and core inflation than the central bank anticipated.

“Nevertheless, just as the Fed was slow on the uptake last year, we expect it to be wrong-footed this year too – and to continue tightening into a slow growth/falling inflation environment,” Ashworth wrote. “On balance, we don’t expect that rapid monetary tightening to tip the economy into recession, particularly not without a more marked tightening in broader financial conditions.”

Several previously dovish members of the Federal Open Markets Committee have come out more aggressively on rate hikes. In a speech on Monday, Governor Lael Brainard said “it is of paramount importance to get inflation down,” noting low- and moderate-income households could face tougher repercussions from inflation than higher-income households.

“Lower-income households spend 77% of their income on necessities — more than double the 31% of income spent by higher-income households on these categories,” she said.

On the same day as the Fed minutes, Philadelphia Federal Reserve Bank President Patrick Harker said in a speech that he expects “a series of deliberate, methodical hikes” throughout the year and said that he is “acutely concerned” about inflation running too high.

“The bottom line is that generous fiscal policies, supply chain disruptions, and accommodative monetary policy pushed inflation far higher than I — and my colleagues on the FOMC — are comfortable with,” Harker told the Delaware State Chamber of Commerce. “I’m also worried that inflation expectations could become unmoored.”

For the average American, the economic situation has become tenuous, and consumer confidence has continually dipped due to the war in Ukraine and the resulting spike in energy prices.  

The Morning Consult reported in March that its index of consumer sentiment hit a new series low, while the Fed’s newly hawkish approach to interest rates will take time to assess. “It’s too early to know if the Federal Reserve can successfully achieve a soft landing,” the group said in its April economic outlook report, predicting that the earliest potential read of the Fed’s success will be in 2023.

Pointing to the extremely strong labor market, meanwhile, the Morning Consult says this moment could be a ripe one for interest rates to finally increase, .

“Under normal circumstances, rising interest rates would pose a risk to jobs growth,” said John Leer, chief economist at Morning Consult. “However, given the usually and persistently high number of job openings, demand for workers could slow without materially limiting the pace of jobs growth.”

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Categories / Economy, Financial, National

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