On Tuesday, the new Federal Reserve Chairman, Jerome Powell, made his first Capitol Hill appearance. For most people, this hardly qualifies as “must-see” TV. In fact, in the collective list of priorities, I’m sure it ranks fairly low.
But as chairman, Powell’s influence and insight on the Fed’s agenda, particularly interest rate hikes, is significant. The Fed serves as the decision-making body for U.S. monetary policy with a mandate to promote the health and stability of our economy and financial system. To meet these objectives, the Fed’s key tool is the manipulation of the benchmark fed funds rate, upon which short-term debt is often based.
Powell’s testimony before the House Financial Services Committee on Tuesday morning sparked further volatility and another sell-off in the stock market. By Tuesday’s close, the Dow Jones Industrial Average had lost 299 points, just one day after it gained 399. On Wednesday, the Dow fell another 380 points.
So, what exactly did Chairman Powell say that sent the stock market reeling?
In his commentary, Powell stated his personal outlook for the U.S. economy had improved since the Fed’s December meeting. Citing continuing strength in consumer and business spending, a growing global economy, rising employee wages, a strong labor market and the expected impact from corporate and personal tax cuts, the current pace of economic growth should further accelerate.
Now, obviously, nothing is wrong with a strong and growing economy. In fact, the American economy has been struggling with lackluster growth for the past eight years. But the recent strength in the U.S. economy has already raised concerns over higher inflation. And Powell’s comments on Tuesday of even stronger economic growth suggest that inflation may rise faster and higher than previously thought.
The concern of an even faster pace of inflation poses a complex dilemma. The problem isn’t so much inflation rising from the current rate of 1.5 percent to the Fed’s 2 percent target rate. The challenge will be trying to keep inflation from soaring above that target rate, which will require interest rate hikes. This concern has been the source of the recent market chaos — how many interest rate hikes will it take to keep inflation contained around that 2 percent level?
Powell is expected to maintain the Fed’s current strategy of gradual rate hikes. At its December meeting, the Fed signaled it would raise interest rates three times in 2018 and twice more in 2019. But Powell’s suggestion of an even stronger U.S. economy has again stoked concerns of a fourth rate hike this year. Interest rate hikes carry risks. And the more rate hikes the Fed imposes, the greater the chance of prematurely stalling our healthy pace of economic growth.
Yes, we know higher inflation is on the way. But until the markets can refine their estimate on how fast inflation is expected to rise, the stock market will likely remain volatile. With seemingly conflicting inflation data from economic reports and from some Fed officials, the markets have been left grasping at straws as they assess future inflationary expectations. On Tuesday, Chairman Powell’s commentary was just one more straw.