Stocks plunge again as Fed’s inflation fight raises recession specter

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Confused? Yeah, me too.

Nearly an hour into trading, the Standard & Poor’s 500 was down 3 percent, while the tech-heavy Nasdaq tumbled 3.7 percent.

So what explains the U-turn?

What happened on Wednesday was. . .unusual.

Fed officials had signaled repeatedly that when they met this week they would boost rates by one-half percentage point.

But last Friday, the outlook for inflation got worse, with the Labor Department reporting that consumer prices in May rose 8.6 percent from a year earlier, the biggest year-over-year increase since 1981. Then, two widely followed monthly surveys showed consumers anticipated inflation elevated for the next one- and five-year periods.

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Wednesday arrived with true uncertainty over what the Fed would do.

“This is an unusual situation to get, you know, some data. . .pretty close, very close to our meeting; very unusual, one that would actually change the outcome,” Fed chairman Jerome Powell said during a post-meeting news conference. “I’ve only seen — in my 10 years plus here at the Fed, I’ve only seen something like that, even close to that, one or two times.”

Officials went with a bigger rate hike, three-quarters of percentage point, with Powell saying “bold action” was called for. He also said, “I do not expect moves of this size to be common.”

Investors’ initial reaction was something like, “Phew, at least we know what to expect.”

The Standard & Poor’s 500 ended the day with a gain of 1.5 percent. The tech-heavy Nasdaq added 2.4 percent.

Then Wall Street slept on it.

There was a lot of information for investors to digest Wednesday after the market closed: Powell’s news conference comments, new quarterly forecasts from members of the rate-setting Federal Open Market Committee, and a subtle but very meaningful shift in the language of the Fed’s statement.

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  • Powell: While the economy is strong and can absorb higher borrowing costs, achieving a “soft landing” — returning to the Fed’s preferred inflation rate without inducing a recession — has been made much tougher by variables beyond its control. Those factors include the war in Ukraine, which has accelerated already-troubling increases in energy and food prices, and pandemic-related contortions in the supply and demand of some goods and services. “This is an extraordinarily uncertain environment,” he said.
  • FOMC forecasts: Economic growth will slow dramatically this year, to a median projection of 1.7 percent in 2022 from 5.7 percent last year. Inflation will come down, but it won’t get close to the Fed’s 2 percent target until 2024. Yet, surprisingly, the Fed projections called for only a modest tick up in the jobless rate, to 3.9 percent in 2023 from a near-record low of 3.6 percent last month. Some economists said it was unrealistic to expect unemployment to remain that low with interest rates climbing and the economy shifting into low gear.
  • The Fed statement: Following its last meeting, in May, the central bank’s policy statement said, “The Committee expects inflation to return to its 2 percent objective and the labor market to remain strong.” That line was gone this time, replaced with, “The Committee is strongly committed to returning inflation to its 2 percent objective. To Fed watchers, the change indicated that officials were growing less confident about their ability to rein in inflation without damaging the job market.
Good morning. Sell, sell, sell.

The Fed has a dual mandate: maintain price stability while promoting maximum employment. Powell’s message on Wednesday was that to support the labor market, inflation must be reduced. He insisted that the Fed wasn’t trying to engineer a recession to beat back rising consumer prices, but investors’ takeaway was that a downturn is becoming ever more likely.

“You really cannot have the kind of labor market we want without price stability,” Powell said. “It’s not going to happen with the levels of inflation we have.”


Larry Edelman can be reached at larry.edelman@globe.com. Follow him on Twitter @GlobeNewsEd.

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