The Fed sees the economic pain ahead. The stock markets now feel it.

Equity markets fell to their lowest levels since 2020 on Friday, continuing a nasty slump that began in August as investors try to tackle headwinds in the US and global economy that are likely to get worse.

Equity indices were on track to end the week with losses, closing the fifth decline in the past six weeks. The Dow Jones industry average fell more than 700 points, or 2.1%, in mid-afternoon on Friday, and dropped below its 30,000 mark. The index appeared to be heading into bear market territory, down 20% from its previous high. The S&P 500 slipped more than 2%, as did the Nasdaq Composite.

The Federal Reserve has pledged to bring inflation back under control, even if slowing the economy means increasing unemployment and households and businesses suffer a little. And although the Fed’s move to raise interest rates this week was widely expected, equity markets are already feeling that pain.

Bad market news – and the Fed’s forecast of a sharp economic slowdown – could also influence campaigns for this fall’s midterm election to Congress, where Republicans hope voters will blame President Biden and Democrats for high inflation.

The full weight of Fed stocks since March – already pushing a key interest rate up 3 percentage points, with more hikes still to come – it may not be heard until the end of this year or next. But financial markets are accepting the central bank’s promise and sending out the alarms, making it clear that no matter how many times Fed officials say they will do whatever it takes to crush inflation, the idea continues to run on Wall Street.

“I think it will likely get worse before it gets better,” said Dan Ives, chief executive and senior equity research analyst at Wedbush Securities.

Analysts say the decline is not just about the Fed’s moves so far, but also about further tightening and the growing likelihood that the Fed cannot lower inflation without causing a recession.

“A soft landing would be very challenging and we do not know – no one knows – if this process will lead to a recession or, if so, how significant that recession would be,” Fed Chairman Jerome H. Powell said Wednesday after the report. Fed rate announcement.

Oversized rate hikes are the Fed’s new normal

The central bank is rushing to cool the economy and lower consumer prices. Officials still don’t see enough progress. But market nervousness already reflects a national and global economy headed for a slowdown.

Oil prices fell to their lowest levels since January. The S&P energy sector also fell more than 6%.

Shares big tech companies including Apple, Amazon, Microsoft and Meta Platforms fell on Friday. (Amazon President Jeff Bezos owns the Washington Post.) Goldman Sachs cut its year-end S&P 500 forecast, mainly driven by rising interest rates. On the other hand, bond yields have risen this week after the Fed’s last rate hike, and 2-year and 10-year Treasury rates have reached unprecedented levels for more than a decade.

The major market indices have declined significantly for the year so far, although the long bull market that has lasted until recently means they are still up more than 30% over the past five years.

The brutal close to the the week came later the Fed has raised rates once again by three-quarters of a percentage point, its third such move and the fifth increase of the year in its fight against inflation. Wednesday’s hike would have been considered extravagant until recently. But Fed officials want to push rates beyond the “neutral” zone of about 2.5%, where rates do not slow or stimulate the economy, and into “tight territory” that dampens consumer demand.

The Fed’s benchmark interest rate is now between 3% and 3.25% and officials expect it to exceed 4% by the end of the year, well into what is considered to be restrictive.

Why does the Fed raise interest rates?

This rate does not directly control the rates of mortgages and other loans. But it affects how much banks and other financial institutions pay to borrow, which helps drive loan prices more broadly. And most importantly, communications from the Fed itself, whether it be Fed officials ‘remarks or policymakers’ economic projections, are key to shaping financial conditions and convincing markets to start evaluating rate hikes that are yet to come. .

Monetary policy is notoriously lagging behind, and Fed rate hikes have so far not yet led to significantly lower inflation. But the moves are manifesting in the economy in other ways.

“Financial conditions have usually been affected long before we actually announced our decisions,” Powell said this week. ‚ÄúThen, within a few months, changes in financial conditions begin to affect economic activity fairly quickly. But it is likely that it will take some time to see the full effects of changing financial conditions on inflation. “

Five graphs that explain why inflation is so high

Diane Swonk, chief economist at KPMG, said traders are also nervous about how the Fed’s moves will be amplified as other central banks also step up their fight against inflation. The Fed was among global central banks to hike rates this week – the Bank of England raised its rate by half a percentage point on Thursday, for example, and warned that the UK may already be in a recession. The fear is that the economies of many nations will not be able to withstand an extreme slowdown. Fed rate hikes also mean higher debt burdens for poor countries.

Economists and traders fear that because all policymakers take big swings at once, they risk exaggerating, not just for their own economies, but for the world.

“Synchronous, not synchronized,” Swonk said of the consecutive moves of various central banks. “This wasn’t planned.”

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