Janet Yellen, if she’s still around today, would be extremely afraid of crashing the stock markets after the recent 666, 1175 and 1032 points plunge. But there’s a new sheriff in town and the new Federal Reserve Chairman Jerome Powell refuses to let himself be intimidated by those crashes. As far as new sheriff is concerned, his priority isn’t the stock markets.
Hence, when Mr. Powell told lawmakers at the Congress that he’s ready to raise interest rates to keep the economy from overheating, the DJIA (Dow Jones Industrial Average) immediately drops like a rock – falling 299.24 points after the closing bell – the first time the U.S. stocks fell in four days as recovery was on its way.
Powell told the Congress 4 things he saw – “We’ve seen continuing strength in the labour market. We’ve also seen continued strength around the globe. We’ve seen some data that will in my case add some confidence to my view that inflation is moving up to target. And we’ve seen fiscal policy become more stimulative.”
In a nutshell, the new chairman signalled the central bank could hike rates more than three times this year in order to contain inflation. Investors and analysts have predicted and anticipated at most 3 hikes this year. Anything more than 3 hikes would be bad news to the U.S. stock markets. Last week alone, the yield on the 10-year note notched a four-year high of 2.95%.
The immediate level of interest is 2.98% and next would be 3.28%. The 10-year is the benchmark best known to investors, and its yield influences a whole range of loans, including home mortgages. The game is simple – if the bond yields go up, you have to sell stocks. If you sell stocks, and the stocks (hopefully) crash, yields come back down.
The goal of the game is for the yields to come down in a meaningful way so that both stocks and bonds markets find the “correct equilibrium” – and thereafter stabilizes. Ward McCarthy, chief financial economist at Jefferies, said – “He’s (Jerome Powell) very optimistic about the economy and he’s optimistic they can hit the inflation target.”
Powell, who was nominated by President Donald Trump and later confirmed by the Republican-controlled U.S. Senate, said he felt the Fed’s current tools for managing interest rates and its 2% inflation target were working fine. However, he acknowledged stronger economic growth may prompt policy makers to rethink their plan for three hikes.
Unlike his predecessor Yellen, the challenge is bigger for Powell. As the economy grows at 3% and unemployment rate has fallen to 4.1% – its lowest since 2000 – Trump administration’s introduction of a substantial fiscal stimulus in the form of a big tax cut and higher spending is feeding fuel to the fire of inflation.
Despite the Dow’s reaction after Powell’s testimony before the House Financial Services Committee, Powell was careful to leave himself plenty of flexibility and room to manoeuvre. He emphasized that he “wouldn’t want to prejudge” the future course of rates, and he pointed out that inflation “remains below our 2% longer-run objective.”
The Fed is expected to push through its first rate increase of 2018 at its next policy meeting on March 20-21. The chance of an interest rate hike in March is close to 100%. The odds of a second increase in the second quarter are up to 80% while a third hikes in the third quarter jumps to 70%. And there’s a 50% chance that Powell will introduce the feared fourth rate hike in the fourth quarter.
The good news is the stock markets didn’t panic, if the 299 points drop is any indicator. But the investors didn’t like what Jerome Powell had said too. They didn’t like that the new Fed chief isn’t worried of the recent stock market jitters. Instead, Powell said that he expects the next two years to be booming years – strong years for U.S. economy.
However, billionaire hedge fund manager Ray Dalio, who had predicted the Great Recession, now sees a 70% chance of a recession before the 2020 presidential election. Joseph LaVorgna, chief economist at investment bank Natixis, said – “It would have been a mistake to hint at four rates hikes this year. If the Fed did four hikes, the yield curve would likely invert, and that would send an ominous sign.”
Regardless whether Powell was playing with fire or knows what he was doing, he has little time to listen to fund managers. He’s on a mission – to keep Wall Street calm, unemployment low and inflation in check. His boss, President Donald Trump, has made it clear he wants a faster economic growth and a booming stock market.
– Finance Twitter
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