After months of inaction by the Federal Reserve to combat inflation, markets responded poorly to rate hikes this spring. However, markets no longer seen concerned. This a relief. The confusion over when and how many rate hikes caused far too much doubt and worry for investors and traders. It didn’t necessarily lead to this current bear market, but it definitely didn’t help.
The Fed was sanguine about inflation for too long
It’s pretty amazing we ever got here. For far too long, Jerome Powell, Chairman of the Fed, had been sanguine about inflation, the economy, and the potential of creating a massive bubble. It took him a long time to accept that inflation was no longer transitory, and it took the Fed months to start raising interest rates.
Powell recently stated that inflation is far too high and needs to come down – and fast. But the Fed is between a rock and a hard place. Too many rate hikes, and they risk stalling economic growth. Too few hikes, and inflation will be hard to stop (and forget about ever getting prices lower again – that may not happen).
Markets no longer seem concerned by rate hikes
Markets respond to every one of Powell’s words, whether it’s a speech or comment during a press conference. At the height of confusion and doubt in April, the VIX rose sharply and stayed elevated for days. That is highly unusual – but so are 2% moves in the stock indices, which have become the norm.
Today, the VIX is moderately elevated while markets continue to drift sideways-to-lower. I interpret this to mean the market is expecting rate hikes (probably several) and does not seem all that concerned.
If rate hikes dampen demand for goods/services, we could enter a recessionary period. It’s not a fun situation, but economic contraction is normal in a growth economy.
Powell and the committee have signaled they will do whatever it takes to tame inflation. While it’s hard to continually take him at his word when he and the committee have been so late and so wrong, the market seems to be acknowledging that these rate hikes are necessary. It’ll be interesting to see how market action shifts with this new attitude.