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Three simple words, but strong enough to shake the financial markets into a new playing field. When Federal Reserve Chair Jerome Powell spoke these words during his two-day semi-annual testimony before Congress this week, doubting traders and investors woke up. Powell acknowledged that recent data showed the trend of disinflation has reversed, while economic data has come in stronger than expected, overturning what was thought to be a slowdown at the end of 2022. According to Powell, “The breadth of the reversal, along with revisions to the previous quarter, suggests inflationary pressures are running higher than expected.” If the data continues to show strong hiring and spending, as well as inflation not falling, Powell suggested rates will need “to go higher for longer, more rapidly,” opening the door for the Committee to raise the fed funds rate by 50 basis points at the end of the month.
By the second day of the meetings, Powell made a point to say no decision had been made yet for the March FOMC meeting, but the Committee “is prepared to increase the pace of rate hikes,” if warranted. The FOMC will make decisions, meeting by meeting, depending on incoming data. To that point, a lot of critical data being released before the March 21-22 meeting that could easily tilt the Fed in any direction – consumer and wholesale inflation reports, retail sales, housing data and consumer confidence reports. The one piece of the puzzle the Fed will not have is the core PCE year-over-year (Y/Y) rate. Even without that, the Fed will be given a good picture of whether January’s strength was an anomaly or a new growth trend.
The impact of the Chair’s stern prognosis was felt deeply in both stocks and markets. The Dow plummeted almost 600 points. The two-year Treasury yield soared to 5.08%, the highest level since June 2007. The 10-year yield, on the other hand, barely moved, staying just below the key 4% level. The change in yields created the most inverted yield curve since 1981 at -109 basis points.
Key Indicators this Week
Jobs – The first piece of data the Fed needs to make its next rate move decision on showed progress is being made. The U.S. added 311,000 jobs in February, more than the estimated gain of 225,000, but far less than January’s 504,000 increase. The unemployment rate increased from 3.4% to 3.6%. Hourly earnings rose 0.2%, the smallest increase in a year, as hours worked also declined. The labor force participation rate rose slightly to 62.5%, the highest in almost three years. The net result is more people are coming back to work, especially at lower-paying jobs, which is keeping a lid on wages. We already learned this week that the number of job openings declined in February from 11.2 million to 10.8 million. Fewer people quit their job last month, pushing the quits rate to the lowest level since May 2021. Plus, unemployment claims rose last week for the first time in over a month and topped 200,000 for the first time since December. The labor market is softening slightly, but not enough for the Fed to call it quits.
Rate Update
The Treasury market underwent a significant turnaround this week. After rising to the highest level in years, a flight to safety spurred by trouble at a technology-focused bank pushed yields much lower. The two-year Treasury yield fell 45 basis points in two days and the 10-year note dropped 30 basis points. The bank scare is considered a one-off situation and not a signal of widespread deterioration in the financial world.
Sarina Freedland – Senior Investment Officer
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