Stock markets fall as U.S. Fed chair Powell reaffirms plan to keep raising interest rates

U.S. Federal Reserve Chair Jerome Powell delivered a stark message Friday: the Fed will likely impose more large interest rate hikes in coming months and is resolutely focused on taming the highest inflation in four decades.

Continued tightening of credit will cause pain for many households and businesses, said Jerome Powell

A man speaks at a government podium.
U.S. Federal Reserve Chairman Jerome Powell speaks during a news conference at the Federal Reserve Board building in Washington, Wednesday, July 27, 2022. On Friday, Powell said the Fed will likely impose more large interest rate hikes in coming months to tame record-high inflation. (Manuel Balce Ceneta/The Associated Press)

U.S. Federal Reserve Chair Jerome Powell delivered a stark message on Friday: the Fed will likely impose more large interest rate hikes in coming months and is resolutely focused on taming the highest inflation in four decades.

Powell also warned more explicitly than he has in the past that the Fed's continued tightening of credit will cause pain for many households and businesses, as its higher rates further slow the economy and potentially lead to job losses.

"These are the unfortunate costs of reducing inflation," he said in a high-profile speech at the Fed's annual economic symposium in Jackson Hole, Wyo. "But a failure to restore price stability would mean far greater pain."

Investors had been hoping for a signal that the Fed might moderate its rate increases later this year if inflation were to show further signs of easing. But the Fed chair indicated that that time may not be near.

"I'm not surprised at anything that he had to say," said David Baskin, founder of Baskin Wealth Management in Toronto. "The biggest fear that the central bankers have is that inflation will get away from them, and by that I mean that everybody will expect inflation to remain high."

Stocks tumbled after Powell's speech on Friday, as investors pondered the prospect of higher borrowing costs sticking around for a while.

The Dow Jones Industrial Average was down by 1008 points, or 3 per cent, by the end of the trading day, while the technology-focused Nasdaq Index was off by even more — almost 4 per cent. 

The Toronto Stock Exchange's benchmark index held up comparatively better, off by 299 points, just shy of 1.5 per cent.

"I think the market was hoping for something a little more ... mild, saying that, you know, 'we don't want to raise interest rates too fast and terrify everybody,'" Baskin added.

The Fed is trying to manage expectations and concerns that come with inflation, like workers and unions potentially seeking higher raises and suppliers hiking prices in the anticipation of rising product costs, he said.

"What the central bankers really need to do is break the cycle of expectation and make people believe that inflation is going to come down and come down quite quickly. And their tool for doing that, of course, is to raise interest rates."

Fed might slow pace of rate hikes 'at some point'

After hiking its key short term rate by three-quarters of a point at each of its past two meetings — part of the Fed's fastest series of rate increases since the early 1980s — Powell said the Fed might ease up on that pace "at some point" — suggesting that any such slowing isn't near.

Powell said the size of the Fed's rate increase at its next meeting in late September — whether one-half or three-quarters of a percentage point — will depend on inflation and jobs data. An increase of either size, though, would exceed the Fed's traditional quarter-point hike, a reflection of how severe inflation has become.

Sal Guatieri, a senior economist at BMO, wrote that economists will be looking for a hike of 50 basis points, with rates peaking between 3.50 per cent and 3.75 per cent, when the next rate increase will be announced on Sept. 21. 

Such a move "should be 'sufficiently restrictive' to cool demand and gradually lower inflation without tipping the economy into a deep downturn," Guatieri wrote.

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While lower inflation readings that have been reported for July have been "welcome," the Fed chair said, "a single month's improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down."

Powell noted that the history of high inflation in the 1970s, when the central bank sought to counter high prices with only intermittent rate hikes, shows that the Fed must stay focused.

"The historical record cautions strongly against prematurely" lowering interest rates, he said. "We must keep at it until the job is done."

Powell's speech is the marquee event of the the Fed's annual economic symposium at Jackson Hole, the first time the conference of central bankers is being held in person since 2019, as it went virtual for two years during the COVID-19 pandemic.

Since March, the Fed has implemented its fastest pace of rate increases in decades to try to curb inflation, which has punished households with soaring costs for food, gas, rent and other necessities. The central bank has lifted its benchmark rate by two full percentage points in just four meetings, to a range of 2.25 per cent to 2.5 per cent.

Those hikes have led to higher costs for mortgages, car loans and other consumer and business borrowing. Home sales have been plunging since the Fed first signaled it would raise borrowing costs.

Slowing the economy without triggering a recession

In June, the Fed's policymakers signaled that they expected to end 2022 with their key rate in a range of 3.25 per cent to 3.5 per cent, and then rise further next year to between 3.75 per cent and 4 per cent. If rates reach projected levels at the end of this year, they would be at their highest point since 2008.

Powell is betting that he can engineer a high-risk outcome: slow the economy enough to ease inflation pressures yet not so much as to trigger a recession.

WATCH | U.S. interest rates will affect Canadians as well:

What the U.S. Federal Reserve's interest rate hike means for inflation

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CBC's senior business correspondent Peter Armstrong helps makes sense of the U.S. Federal Reserve's interest rate hike — and what it might signal for the Canadian economy.

The Fed chair's task has been complicated by the U.S. economy's cloudy picture: On Thursday, the U.S. government said its economy shrank at a 0.6 per cent annual rate in the period between April and June, the second straight quarter of contraction. Yet employers are still hiring rapidly, and the number of people seeking unemployment aid — a measure of layoffs — remains relatively low.

At the same time, inflation is still crushingly high, though it has shown some signs of easing, notably in the form of declining gas prices.

At its meeting in July, Fed policymakers expressed two competing concerns that highlighted their delicate task.

According to minutes from that meeting, the officials — who aren't identified by name — have prioritized their inflation fight. Still, some officials said there was a risk that the Fed would raise borrowing costs more than necessary, risking a recession. If inflation were to fall closer to the Fed's two per cent target and the economy weakened further, those diverging views could become hard to reconcile.

With files from CBC's Meegan Read