Consider this: the US central bank sees financial-market pain as part of the process to tackle inflation – a thought investors haven’t known in more than a generation.
Powell this week said: “Financial conditions overall have tightened significantly. Broadly across financial conditions you’re seeing that. And that’s what we need.”
The comments amount to Powell effectively endorsing a selloff in US equities that took the S&P 500 to the edge of a bear market (a 20% decline from the high) last week. Another component of the tightening in financial conditions has been higher premiums on corporate bonds. Mortgage rates have also climbed, and the dollar has appreciated.
Why does the Fed “need” to see such developments?
Because all these moves will serve to damp demand. Sliding stocks will dent household and business confidence, encouraging them to rein in spending. Higher borrowing costs will similarly undermine willingness to buy things — homes, cars, commercial centers, a company’s upgraded computer network, whatever the case may be.
And by damping demand, the Fed can bring things closer to where supplies are, Powell explained. And that in turn will bring down price pressures.
“The only realistic way to break the wage-price spiral is to push up the unemployment rate. If the Fed does not do this by accident, they will have to do it by design,” said Philip Marey, senior U.S. strategist at Rabobank.
“A recession is the inevitable outcome.”
