Federal Reserve chair Jerome Powell sent shivers through financial markets when he told the US Senate on Tuesday that interest rates may have to rise by more than previously forecast.
He confirmed concerns that stronger than expected economic data so far this year could mean the ultimate level of interest rates is likely to be higher than previously anticipated and that the Fed is ready to increase the pace of its hikes again if needed.
After seeming to be on a steady decline since last summer, reports on inflation last month were surprisingly hotter than forecast. So did other data on the economy, including the job market in January and spending by US consumers.
Powell’s comments saw US bond yield jump – the 10-year yield rose to 3.96% but the yield on 2-year bonds (which are more easily influenced by sentiment about the Fed’s words and actions) topped 5% for the first time in years at 5.015%.
It is the first time the 2-year yield has topped 5% since more than 17 years ago in January, 2006.
That spooked many investors and sent major indices sharply lower. The Dow lost 575 points or 1.7%, the S&P 500 fell 62 points or 1.5% and the Nasdaq dropped 145 points or 1.2%.
Gold was squelched, dropping more than $US30 to around $US1,820 an ounce; oil’s week-long rally was crunched, US crude shedding more than 3% to tumble back to just over $US77 a barrel and copper slumped nearly 3% to retreat back under $US4 a pound.
There will be a lot of focus on Friday’s jobs data for February which are forecast to be half (around 255,000) January’s massive 517,000 (and 563,000 if the upward revision in December is added in.
“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” Powell said.
“Restoring price stability will likely require that we maintain a restrictive stance of monetary policy for some time.”
Those comments in his morning appearance sent a wary Wall Street sharply lower and the fall continued through the rest of the session. Suddenly the possibility of rate rises of 0.50% (or even 0.75%) are back in the spotlight ahead of the Fed meeting on March 21 and 22.
Now investors and others accept the idea that inflation is stickier than previously believed and has supplanted the previous idea of a straight line fall in inflation from last June’s peak of 9.1%.
Now its clear the Fed will be keeping rates much higher for longer, even after future increases.
Higher rates can drag down inflation because they slow the economy, but they hurt stocks and other investments such as commodities (because of the higher value of the US dollar and the higher possibility of recession later on.
Powell also urged US politicians to lift the federal debt ceiling.
“Congress really needs to raise the debt ceiling … if we fail to do so, I think that the consequences are hard to estimate, but they could be extraordinarily adverse and could do long-standing harm,” Powell told the Senate Banking Committee.
The Congressional Budget Office last month said the US Treasury will exhaust its ability to pay all its bills sometime between July and September, unless the current $US31.4 trillion cap on borrowing is raised or suspended.
Republicans, who control the US House of Representatives, want to withhold a debt limit increase until Democrats agree to deep spending cuts. Democrats say the debt limit should not be “held hostage” to Republican tactics over federal spending.
Republicans never raised the issue when Donald Trump was President, even though debt ballooned in his term because of huge tax cuts and a sluggish economy.
A debt ceiling showdown in 2011 hit markets and led to a downgrade in America’s credit rating by Standard & Poor’s. That rating is currently AA+ with a stable outlook.
