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Markets fall after Fed Chair Powell urges patience

Stocks fell sharply Thursday after the Fed chair said prices were likely to increase later this year, even as he cautioned that any inflation would be short-lived

Federal Reserve Chair Jerome H. Powell on Capitol Hill on Dec. 1. (Susan Walsh/Pool/Reuters)

Stocks fell sharply Thursday after Federal Reserve Chair Jerome H. Powell did not reassure investors that inflation and bond yields would stay under control when the pandemic ends and economic activity rebounds.

The Dow Jones industrial average closed down 350 points, or roughly 1.1 percent, on Thursday. The S&P 500 and Nasdaq composite index closed down 1.3 percent and 2.1 percent, respectively.

Long-term interest rates have popped over the last few weeks. That’s a sign that investors expect the economy to surge later this year — and possibly trigger unwanted inflation if the rebound happens too quickly.

Treasury yields jumped to more than 1.5 percent after Powell spoke Thursday at the Wall Street Journal Jobs Summit. The benchmark 10-year yield also spiked last week to 1.6 percent, which jolted the markets and spurred a subsequent sell-off.

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The inflation debate has picked up steam as more Americans become vaccinated and there’s hope that, as a result, economic activity and consumer spending will surge later this year. That could happen as President Biden’s $1.9 trillion stimulus package washes over the stronger-than-expected recovery.

Powell on Thursday said those dynamics “could create some upward pressure on prices.” But those effects would be temporary and not register as broad-based, sustained inflation. Powell emphasized that this economy, even as it reopens from a devastating pandemic, looks nothing like the economy that was hounded by runaway inflation in the 1960s and 1970s.

“At the Fed, we are well aware of the history and how it happened, and we’re not going to allow it to happen again,” Powell said. “It was a situation where the Fed didn’t step in when it should have, when inflation pressures were building. That’s not at all the current situation.”

The Fed aims for 2 percent annual inflation and has struggled to hit that benchmark for years. In August, the Fed unveiled a policy framework that said it would temporarily tolerate inflation that creeps above 2 percent and that inflation would have to be on that track before the Fed considers responding with an interest rate hike.

Powell said last week’s bond yield surge was “notable and caught my attention.” But he said the Fed looks at a “broad range of financial conditions … and that’s really the key.”

Still, that insistence was not enough to prevent Thursday’s sell-off in the markets.

“It is clear that the bond market is pricing in greater inflation on the back of economic reflation this year,” wrote Joe Brusuelas, chief economist at RSM, after Powell’s remarks.

“Powell went out of his way to reinstate the word ‘patient’ into the discussion on risk linked to inflation,” Brusuelas added. “That should be understood to mean that the Fed will not act to preempt the nascent economic recovery because of what is widely expected, and what Powell stated, will be a midyear increase in inflation that will be a function of year-ago base effects.”

Powell’s comments Thursday echoed those of Federal Reserve Gov. Lael Brainard, who said earlier in the week that she was “paying close attention to market developments.”

“Some of those moves last week, and the speed of those moves, caught my eye,” Brainard said.

Both Powell and Brainard said they would worry if they saw “disorderly conditions” or persistent tightening in financial conditions that would slow the economy’s growth.

For now, though, Fed officials do not see a pressing threat or reason to reevaluate current policy. The Fed has pledged to keep interest rates near zero until there is significant progress toward the central bank’s goals on maximum employment and stable prices. The Fed is also is buying $120 billion a month in Treasurys and mortgage-backed securities.

“Fed chair Powell’s remarks today tracked governor Brainard earlier this week in expressing a more careful tone on bond market developments but broke no new ground, disappointing those who had hoped for a stronger pushback against rising yields,” wrote Krishna Guha and Ernie Tedeschi of Evercore ISI in an analyst note.