Rising inflation is forcing rate hikes and market volatility

Federal Reserve Chairman Jerome Powell tried to walk a fine line Wednesday in the first of two days of congressional testimony between explaining why the central bank paused its interest rate hikes while also acknowledging that inflation is far higher than it desires.

The Fed put a hold on its aggressive campaign of raising interest rates for what would have been the 11th straight time, saying it wanted to digest the effects of a series of hikes that have lifted borrowing costs by 5% since March 2022. At the same time, more than half the members of the Federal Open Market Committee said they expected to have to raise rates two more times this year.

“Inflation has moderated somewhat since the middle of last year,” Powell told members of the House Financial Services Committee in his opening remarks. “Nonetheless, inflation pressures continue to run high, and the process of getting inflation back down to 2 percent has a long way to go.”

Republican committee Chairman Patrick McHenry of North Carolina told Powell to continue his resolve in fighting inflation, blasting Democrats for irresponsibly stimulating the economy during the pandemic and laying the foundation for the worst inflation in 40 years.

“Clearly our economy is in a precarious position,” from rising rates, tighter credit conditions and inflation, McHenry said.

California Democrat Maxine Waters, the ranking member, lauded the Fed for putting a hold on interest rates and warned that the strong growth in the labor market seen in the past couple of years would be threatened by more interest rate hikes. She cited the Inflation Reduction Act, passed by Democrats nearly a year ago, with helping to bring down the rate of consumer inflation from 9.1% last year to 4% in May.

Waters also took a swipe at Republicans, who she said were more concerned with gas stoves than they are with improving the banking system and holding bank executives accountable.

Powell noted the Fed’s actions to date in raising rates, but added: “We have raised our policy interest rate by 5 percentage points since early last year and have continued to reduce our securities holdings at a brisk pace.”

“We have been seeing the effects of our policy tightening on demand in the most interest rate-sensitive sectors of the economy,” Powell said. “It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation.”

In response to a question from McHenry, Powell said that “given how far we’ve come, it may make sense to move rates higher but at a more moderate pace.”

Stocks have run up in recent weeks on expectations the Fed was nearing an inflection point but have taken their own pause this week awaiting Powell’s testimony and a clearer sense of where the economy is headed.

“Periods of economic regime shifts are difficult for policymakers to manage,” Jeffrey Roach, chief economist, and Lawrence Gillum, chief fixed income strategist for LPL Financial, said on Tuesday. “This current environment could be eerily similar to early 2007, when the Fed held a tightening bias on rates as they believed the housing market was stabilizing, the economy would continue to expand, and inflation risks remained.”

“Both the January 2007 statement and the most recent one last week specifically mention the FOMC’s process in determining the extent of additional policy firming that may be needed,” they added. “Clearly, those expectations were not met since we know what happened in later quarters. Despite the reference to 2007, our baseline is that the economic slowdown does not produce another ‘2008,’ yet investors should anticipate some volatility as the economic outlook remains cloudy.”