Federal Reserve chair Jerome Powell told the Senate banking panel on Tuesday that extra rate hikes will be needed to douse the recent trend of firming inflation and persistently strong job growth. The S&P 500 lost ground in early Tuesday stock market action as markets priced in higher odds of a 50-basis-point rate hike on March 22.
While Fed policy is still data-dependent, Powell's testimony suggests that it could take a surprisingly weak jobs report on Friday and CPI report next week to keep the next hike to 25 basis points.
Powell said that incoming data, as well as upward revisions to prior data, "suggests that inflationary pressures are running higher than expected" by Fed officials when they met at the start of February. As a result, "the ultimate level of interest rates is likely to be higher than previously anticipated."
Chair Powell notably didn't take a half-point hike off the table for the upcoming meeting. "If the totality of the data" warrant, Powell said, the Fed is "prepared to increase the pace of rate hikes."
Fed Rate-Hike Odds
The Fed also will release new quarterly projections on March 22. Chair Powell's hawkish testimony indicates that officials could pencil in a couple of extra rate hikes in coming months. The last batch of projections in December showed the Fed's key interest rate peaking at a range of 5% to 5.25% this year.
Since the Feb. 3 January jobs report showed robust hiring and lower unemployment, financial market pricing has undergone an abrupt shift. Before, markets expected the Fed to hike less than official projections and begin cutting rates later this year. Ahead of Powell's testimony, markets were pricing in just over 50% odds that the Fed will hike its key rate to a range of 5.5% to 5.75% by the Sept. 19-20 meeting. That implied two extra hikes compared to the Fed's latest projections.
After release of Powell's testimony, odds that rates will rise to 5.5%-5.75% reached 70%.
Plus, odds of a 50-basis-point hike on March 22 spiked to 48% from 30% before Powell's testimony. More firm inflation data and a strong jobs report could tilt the Fed to making a half-point move.
S&P 500 Reaction
After release of Powell's testimony, the S&P 500 turned solidly lower, losing 0.7% in Tuesday morning stock market action.
Up until now, the S&P 500 has largely held its ground over the past few weeks despite hot economic data and rising Treasury yields. The S&P 500 has so far found support at its 50-day moving average, staging a rally above that level on Friday. Another test of the 50-day line could be coming.
U.S. Economic Optimism Hits 15-Month High; Investors Feel Fine, Others Not So Much
As of Monday's close, the S&P 500 was 15.6% below its record closing high but up 13.2% from its bear-market closing low on Oct. 12.
The 10-year Treasury yield edged up one basis points to 3.995% Tuesday morning.
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Powell: Err On The Side Of Hiking Too Much
The Fed has two reasons to keep hiking interest rates that may dictate policy near-term.
First, Fed officials believe the costs of not hiking enough, which could lead inflation to become entrenched, are much greater than the costs of hiking too much. Second, until recently, Fed officials had pretty much failed to convince markets that rates would move higher and stay there for longer. That had consequences. Treasury yields fell, lowering borrowing costs and helping give the economy a second wind.
Now that markets are finally listening to the Fed, policymakers probably won't want to hike less than markets are betting.
