Week of August 29, 2022

Since early June, investors had been hoping that the Federal Reserve would take more of a dovish approach to future interest rates hikes, seeking an economic “soft landing.”  Those hopes were dashed last Friday when speaking from Jackson Hole, Wyoming, Federal Reserve Chair Jerome Powell made it clear that the Fed is prepared to hike interest rates even if it causes economic pain. “While higher interest rates, slower growth, and a softer labor market conditions will bring inflation down, they will also bring some pain to households and businesses,” Powell said in his prepared remarks. “These are the unfortunate costs of reducing inflation.  But a failure to restore price stability would mean far greater pain.”

 On Friday, the Dow fell 1,008 points, or just over 3%, for its worst day since May.  The S&P 500 and NASDAQ fell 3.4% and 3.9%, respectively, for their worst days since June.  The drop erased the August gains for all three averages.

In the bond market, the yield on the benchmark 10-year Treasury surged above 3%, and the 2-year Treasury yield spiked to 3.45%, its highest level since 2007.  While the spike in bond yields is weighing on bonds, the stock market is also greatly affected.  “Chair Powell’s speech was a god reminder that 2-year Treasury yields are more important to equity markets than whether the FOMC moves by 50 or 75 basis points at upcoming meetings,” DataTrek’s Nicholas Colas said Monday, pointing out that U.S. large cap stocks have been sensitive to the 2-year benchmark.

Market analysts have suggested that Powell’s hawkish comments last Friday and the market’s reaction is evidence that economic reality of persistently high inflation is setting in.  It was declining energy prices that offset rising food, shelter and medica care prices that made for no increase in CPI in July.  With oil back above $90 per barrel, August CPI may well surprise to the upside.