A stock market reality check

Federal Reserve Chairman Jerome Powell speaks at a press conference following a meeting of the Federal Open Market Committee in Washington, DC on May 4.


Win McNamee/Getty Images

Well, so much for the optimistic assurances about inflation, interest rates and recession. Federal Reserve Chairman Jerome Powell’s relatively sunny stance on Wednesday’s three days after the Federal Open Market Committee’s last meeting had pleased investors. But they gave up all market gains and then some on Thursday as the prospect of a tougher reality set in.

The Dow Jones fell more than 3% and the S&P 500 3.56%, while the tech-heavy Nasdaq lost 5% in a single day. Stocks could rebound on Friday, but the sharp price swing over the past two days shows how uncertain investors are about the outlook for the economy as the Fed finally tightens monetary policy after years of essentially free credit.

The volatility is not surprising given the political and risk variables. Investors are trying to judge how much the Fed will need to raise rates to snap off the highest inflation in 40 years. At the same time, the Fed promises to reduce its bond portfolio, which means taking a step back from long-term bond prices. Markets are trying to make sense of a political environment no one has seen in four decades.

The market drop does not mean the Fed is wrong to tighten. In our view, he has no choice if he is to avoid a return to the long-term inflation woes of the 1970s.

But the economic risks are significant, despite Mr. Powell’s assurances on Wednesday that the economy is strong. Even normal monetary tightening cycles produce financial losses as liquidity declines. This time around it could be worse because the monetary excesses were so extreme in 2020 and 2021. The surprise will be if there are no bad financial surprises – i.e. credit defaults – this year and next.

The best economic policy response would be for the White House to stimulate the economy’s supply side by abandoning plans to raise taxes and punishing corporations with new regulations and other forms of harassment. It could also end the political war on fossil fuels.

But the Biden administration seems unwilling to do any of that, so prepare for more financial and economic volatility to come.

Journal Editorial Report: It insults the millions of people who have repaid their loans. Images: Getty Images for We The 45 Million Composite: Mark Kelly

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Appeared in the print edition of May 6, 2022 under the title “A Market Reality Check”.


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