The stock market tantrum to begin the year is not really about investors reassessing the economy, geopolitics in Ukraine, or even corporate earnings power. It’s about a newly engaged Federal Reserve ready to fight inflation. And soon.
Investors hope for clarity as soon as this week. The central bank’s interest rate setting committee meets for two days in the week ahead. The discussions conclude on Wednesday with the group’s statement on the state of the economy, its current reduction of buying government and mortgage-backed bonds, and an artfully phrased but probably vague outlook on its target short-term interest rate.
The markets have been repricing themselves expecting that first rate hike as soon as March. Stocks and bonds have sold off. The S&P 500 is down more than 3%. The NASDAQ has fallen more than 7% since the start of the year. The 10-year bond yield has jumped to a two-year high.
All this noise can be quieted down with clarity from the Federal Reserve. However, clarity comes with less flexibility than the bank usually reserves for itself. It is likely to offer, as it did most recently in December, its usual assurances that it is “prepared to adjust the stance of monetary policy as appropriate if risks emerge” that threaten its twin goals: full employment and steady prices.
Investors aren’t asking if the Fed will raise interest rates. The twin concerns for the markets are when and by how much will interest rates rise.
Raising rates sooner aims to address inflation faster. Raising rates faster aims to squeeze worrisome inflation out of the economy sooner. Waiting and going slow on rate hikes will be less of a shock, but risks higher-than-comfortable inflation while interest rates are rising. That can be a poisonous combination for the economy.
One day after the Fed finishes its meeting, the first look at the fourth-quarter GDP will be released by the government. The Federal Reserve Bank of Atlanta’s GDPNow forecast estimates the American economy grew at a 5% annual clip at the end of last year. It would represent an accelerating economy compared to the third quarter’s 2.3% GDP increase.
This pickup can give the Fed some comfort that tapping the economic brakes by rising interest rates this spring won’t steer the economy off course.
Financial journalist Tom Hudson hosts “The Sunshine Economy” on WLRN-FM in Miami, where he is the vice president of news. He is the former co-anchor and managing editor of “Nightly Business Report” on public television. Follow him on Twitter @HudsonsView.