Fed Chair Powell recently warned that benchmark interest rates are likely to rise more rapidly than previously anticipated, potentially placing Wall Street and the economy on edge as higher borrowing costs stoke inflation fears.
Since late last year, the Fed has raised its key rate eight times and it is expected to keep this trend. But Powell warned that further tightening may be needed if inflation cannot be kept under control.
1. Media Power
On Wednesday, Federal Reserve Chair Jerome Powell warned that the central bank may need to raise interest rates more aggressively in the months ahead. His words caused stock prices to tumble shortly after he began speaking.
The Fed's hawkish attitude on interest rates is causing investors to shudder, fearing higher borrowing costs will discourage spending, weaken economic growth and curb inflation. Furthermore, higher rates could potentially trigger a recession.
Though economists generally anticipate no rate hikes until March, investors are nervous about what comes next. After raising short-term rates three times this year and many expecting a fifth hike this month, CME Group's FedWatch tool suggests investors may be expecting another rise this month.
That is why it's essential to monitor the Fed's actions closely. If they remain hawkish, it could negatively affect the economy and cause stocks to decline further.
If the Fed raises interest rates too quickly, it could send the economy into recession - a risk that's particularly acute when its action comes at the end of negative economic growth. That's why investors have been closely following the first two quarters' worth of economic data and paying close attention to Powell's remarks.
In addition to the general market, crypto investors have been closely following the Fed's decisions. Bitcoin, the leading cryptocurrency by market cap, surged 2% in an hour after Powell's remarks and has gained over 4% over the past 24 hours.
Since the start of this year, the crypto market has seen considerable volatility as investors began trading digital assets like stocks. Analysts anticipate that Bitcoin will likely continue its upward trajectory in the months ahead, though some fluctuations may take place after the Fed confirms its interest rate hike.
Though the value of cryptocurrencies like bitcoin are often determined by speculation, it's still essential for the public to comprehend how markets function. By understanding what drives the market and making informed decisions, investors can assess the liquidity of digital assets before investing.
2. Rules
The Federal Reserve Chair is accountable for a range of tasks, such as meeting with Congress, managing interest rates and encouraging maximum employment. As one of the world's most powerful positions, any changes made by the Fed have an immediate effect on global economies.
Over the past year, the Fed's monetary policy has been tightening steadily; raising its key rate, which affects consumer and business loans, by at least half a percentage point six times consecutively. At this time, they've attempted to contain inflation and slow the economy's decline.
Inflation has been rising at an annualized rate of 2.2%, which is higher than the Fed's target rate of 1%. But officials have cautioned that a sustained rise in prices could thwart their efforts to bring inflation back down.
That poses a concern, as the central bank is dedicated to price stability and full employment. But if inflation rises too rapidly, they could need to raise rates again in the coming months.
As the Federal Reserve attempts to cool inflation, it also is cutting its monthly bond purchases and offloading some assets on its balance sheet. It expects to begin shrinking its $4.5 trillion balance sheet later this year, mostly by allowing some proceeds to mature each month.
Rate hikes and other policy actions have given investors renewed optimism, leading to higher stock prices and lower bond yields. But if the Fed continues to steer policy in an unfavorable direction, it could cause slower economic growth and higher unemployment - two outcomes which the Fed has long warned could negatively affect inflation.
Inflation is a critical concern for the Fed, and Powell has been vocal about it. Last year in an interview, he warned against excessive inflation as it could prove hazardous to the economy.
It's unclear if Powell will be successful in this effort, but his remarks Tuesday focused attention back on the central bank's strategy to combat inflation. He told the Senate Banking Committee that if inflation doesn't improve, perhaps another interest rate hike may be necessary.
3. Liquidity
On Tuesday, Fed Chair Powell delivered his semiannual report to Congress and indicated the central bank is likely to raise interest rates even faster and higher than anticipated. This unexpected move alarmed stock markets which had been hoping for a slowdown in hikes later this year if inflation were showing signs of weakening.
The warning came as the economy added more than 517,000 jobs in January and unemployment dropped to a level not seen since the 1960s, signaling strong economic indicators. Yet inflation has also been declining rapidly over recent months - an upward trend Powell warned may need to be sustained if inflation is to slow its fastest growth in decades.
He hinted that the Fed could raise rates "a couple of times more" than anticipated, noting they are monitoring inflation closely. Already this year, officials have predicted that they may raise rates up to about 5 percent before stopping at some point in the future.
He also stressed the need for the Fed to closely monitor labor costs, which have been rising at a faster rate than most economists expected. While inflation has decreased in core goods, it remains high in core services where labor costs have seen the greatest spike.
Liquidity is a measure of how easy it is for an individual or company to convert assets into cash and fulfill financial obligations, like payments on bills and debt. It can help companies decide how much debt they should borrow for growth or investing in new equipment. Furthermore, having a current ratio above one indicates that a business is doing well financially--meaning there are more cash and marketable assets than debt).
4. Investors
On Tuesday, Federal Reserve Chair Jerome Powell informed lawmakers of his plan to raise interest rates sooner and higher than most economists had predicted just a few months prior. As a result, stock markets sold off sharply in the hours following his testimony.
Investors who use the Federal Reserve's benchmark interest rate to value stocks and cryptocurrencies will experience greater-than-normal volatility as they eagerly await news of a Fed hike in March. A hike could cause financial markets to believe the economy is headed for recession, leading to higher-than-normal volatility ahead of this important event.
Investors are also concerned about inflation's potential effects. Prices have been rising faster than average this year, and inflation is one of the primary drivers behind the Fed's ongoing rate hike cycle.
Economic experts believe the current pace of Fed tightening has already begun to have an effect on the economy, leading some investors to flee risky investments and raising prices for safe-haven assets like gold. Investors are concerned whether inflation can be maintained long enough for job creation and economic expansion to proceed.
If the Fed continues its path of raising interest rates, it could cause an economic slowdown and leave many workers out of work. Furthermore, Powell stated that high inflation isn't necessarily the best way to reduce unemployment rates.
Recently, the economy has shown signs of recovery with unemployment falling below 4%. Nonetheless, he reiterated that the central bank remains committed to keeping inflation at bay until it stabilizes.
He further noted that it will take time for inflation to return to 2%, noting "it's a long process." According to him, the Fed could potentially hike rates several more times before stopping, depending on how much further inflation can be brought down.
Ultimately, the outcome of this week's Federal Open Market Committee (FOMC) meeting will determine if rates are increased or not. Based on recent trends and expectations, however, it appears likely that the Fed will raise rates by 50 basis points at this gathering.
The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.