Concern that the Federal Reserve could be setting up for the biggest interest rate hike in almost 30 years this week, just days after a worse-than-expected inflation report dropped, continued to roil markets on Tuesday, which were mixed as of midday.
On Monday, the S&P 500 ended the day down about 4%, pushing the index to 21% below a record high set early this year and passing the 20% loss threshold that defines the start of a bear market. The tech-heavy Nasdaq composite crossed that loss benchmark in March.
The Fed has previously signaled that it would likely follow up a 0.5% increase to its benchmark interest rate last month with another 0.5% bump this month, continuing an aggressive strategy to increase the price of debt, slow spending and rein in record high inflation. A Department of Labor report of 8.6% inflation last week ran counter to widespread expectations of some slowdown in skyrocketing prices for goods and services. The gloomy news sparked a rash of sell-offs across U.S. stock markets as well as the cryptocurrency sector which is riding steep declines since hitting valuation peaks late last year.
And now, many believe the Fed may have no choice but to adopt a .75% increase for the first time since 1994.
What gives? At the center of the sell-off is the Federal Reserve’s effort to control inflation by raising interest rates. The Fed is scrambling to get prices under control and its main method is to raise rates, but that is a blunt tool that could slow the economy too much and cause a recession.
“The real calm in today’s market is driven very significantly by the focus on this week’s Fed decision,” said Greg Bassuk, CEO of AXS Investments. “Today’s is either the calm before the storm or the calm that will hopefully represent an extended period of calm.”
Other central banks worldwide, including the Bank of England, have been raising rates as well, while the European Central Bank said it will do so next month and in September.
The war in Ukraine is sending oil and food prices sharply higher, fueling inflation and sapping consumer spending, especially in Europe. COVID-19 infections in China, meanwhile, have led to some tough, business-slowing restrictions that threaten to restrain the world’s second-largest economy and worsen snarled supply chains.
What about the R-word? Wall Street is convinced the Fed will take more severe action against inflation Wednesday and also believes that it will raise rates by another three-quarters of a point in July, according to CNN. Nearly 90% of investors believe the Fed will hike rates by that same amount next month, following similar expectations from Goldman, Jefferies and Barclays.
Such strong medicine for inflation could pose a threat to the U.S. economy, however. In a note to clients Tuesday, Goldman analysts warned tightening financial conditions could further drag growth “somewhat beyond” what the Fed “should be targeting to have the best chance of bringing down inflation without a recession,” per CNN.
That could make the elusive “soft landing” that Powell has aimed for all but impossible to achieve. When the Fed raises rates, it almost always crash-lands the economy into a recession. But, according to CNN, there have been rare instances when the Fed has cooled off the economy and kept prices in check without sending the economy spiraling into a downturn: Once in 1965, and again in 1984 and 1994.
Contributing: Associated Press