Global equities are trading sharply lower as investors continue to process extremely aggressive actions from central banks in response to red-hot inflation figures.
Fed Delivers Largest Rate Hike Since 1994
The Federal Reserve hiked interest rates by 75 basis points Wednesday, marking the most hawkish stance in its fight against inflation since 1994. At the long-awaited Federal Open Market Committee (FOMC) meeting yesterday, the Fed raised its benchmark funds rate to a range of 1.5% to 1.75%—the highest in more than two years.
Powell said:
“We want to see progress. Inflation can’t go down until it flattens out. If we don’t see progress [...] that could cause us to react. Soon enough, we will be seeing some progress.”
The members of the committee hinted at a significantly stronger pace of rate increases moving forward to curb the inflation, which hovers around its highest level in more than 40 years.
The FOMC members also notably slashed their growth estimate for this year as they now expect a mere 1.7% growth rate in the gross domestic product (GDP), down from 2.8% in March.
Moreover, inflation estimates based on personal consumption expenditures (PCE) climbed to 5.2% in 2022, up from 4.3%, while forecasts for core inflation—which does not account for volatile food and energy prices—stood at 4.3%, up just 0.2% from an earlier prediction.
The data also showed that core PCE inflation hit 4.9% in April, which means that the new estimates indicate an easing of rising costs throughout the remainder of the year.
Overall, economic activity has been picking up the pace after seeing a drawdown in the year’s first quarter, the FOMC said in the statement.
The unemployment rate remained low over recent months. The committee said in a press release:
“[Inflation continued due] to supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.” [The central bank remains] strongly committed to the 2% inflation target.”
Economic growth was down 1.5% in the first quarter year-over-year, while the second-quarter numbers were relatively flat. Generally, two consecutive quarters of economic decline are commonly seen as an indicator of a recession.
How Markets Reacted and What’s Next for U.S. Equities
Market volatility increased following the Fed announcement, with stocks moving higher after the central bank’s chairman Jerome Powell spoke at the press conference.
“Clearly, today’s 75 basis point increase is an unusually large one, and I do not expect moves of this size to be common.”
He also expects to see another rate hike of 50 or 75 basis points in July, adding that the Fed will “continue to communicate” its intentions as clearly as possible. Markets initially rallied on this announcement as the bond market had largely priced in another 75 bps rate hike in July.
However, the market reacted completely differently on Thursday. The Dow Jones Industrial Average, which tracks the performance of 30 prominent U.S.-listed companies, dropped below the key 30,000 support level as investors feared that the new rate hike would tip the economy into a recession.
Although the stock market index initially climbed on the news, before seeing a notable decline Thursday to its lowest mark since January last year. The Dow Jones slipped 2.4%, or 740 points, while the S&P 500 and the NASDAQ Composite lost 3.1% and 3.8%, respectively.
It is likely that investors were also spooked by an unexpected decision from the Swiss National Bank (SNB), which increased its benchmark rate by 0.5% on Thursday to curb inflation.
Given how short-lived and weak the rebound in equities was, as well as a shallow attempt by Bitcoin to move higher after a sharp selloff, it is very likely that the markets will continue to move lower to reflect surging bond yields.
The NFP and CPI data for July will likely shape how the markets perform in July, while the bears remain in full control until then. Looking beyond July, investors will look for clues about Fed’s next actions after Powell said the FOMC would continue to take decisive actions to push inflation significantly below current levels.
In the meantime, yields will continue to surge as investors brace for a 4% Fed terminal rate. Any information that may hint that the Fed will stop increasing rates sooner than expected is very likely to ignite a sharp market rebound, given the magnitude of the ongoing selloff.
Overall, an extremely aggressive Fed will most likely push the U.S. economy into a recession, with JPMorgan strategists estimating that the stock market has already priced in an 85% chance of a recession.
Bank of England Follows Up With 5th Rate Hike
Elsewhere, the Bank of England (BoE) introduced a less aggressive rate hike of 25 basis points Thursday, but it noted that it was prepared to act “forcefully” if needed to combat the inflation which currently runs at more than 11% in the country.
The bank’s Monetary Policy Committee voted 6-3 to raise the rates to 1.25%, while the minority of members voted for a 50 bps hike.
Interest rates in Britain now stand at their highest level in more than 13 years, marking the fifth time England’s central bank hiked rates since December.
However, the BoE has faced backlash over the recent period, with its critics saying that it is moving too slowly to curb inflation, which could lead to long-term economic consequences.
the BoE said:
“The scale, pace, and timing of any further increases in Bank Rate will reflect the Committee’s assessment of the economic outlook and inflationary pressures.”
The central bank’s benchmark interest rate is expected to end 2022 at 3.4%, according to the midpoint of the forecasted target range, up by 1.5% from March estimates. The FOMC expects the benchmark rate to then surge to 3.8% in 2023, up 1% from what was forecasted in March.
Without any surprises, shares in the U.K. experienced a decline. The FTSE 100 dropped over 3.3% to hit the lowest level in more than three months. On the other hand, the British pound surged to gain almost 1.5% against the U.S. dollar.
Summary
The U.S. stock market is trading sharply lower in response to a 75 bps rate hike delivered by the Fed. The BoE followed up with the fifth rate increase since December, while the SNB delivered an unexpected rate hike as central banks around the globe race to stop growing concerns over stagflation from surging further.