Fed Will Hike Rates Faster Than Expected. That Means A Crash Comes Sooner.

The Federal Reserve prides itself on transparency. They are determined not to surprise markets with rate hikes or rate cuts the market doesn’t see coming. The same goes for quantitative easing (QE) and quantitative tightening (QT).

Of course, policy changes are needed from time to time. Once the Fed decides on a policy change, they announce it well in advance of the actual decision through a combination of speeches, op-eds, and interviews.

Anyone who does not see a Fed decision coming has not been paying attention. Still, the process just moves the shock effect from the official meeting calendar to the unofficial calendar of speeches and the like.

A shock is still a shock. Jay Powell delivered remarks last Thursday at a CNBC panel, as reported in this article.

The market already knew that the Fed was on a path of hiking rates. The first increase was on March 16, 2022. Markets fully-expected further rate hikes at subsequent meetings on May 4 and June 15 and beyond. Markets had even priced in a 0.50% hike on May 4 compared to the 0.25% hike on March 16.

Still, Jay Powell went further in his remarks. He said, “It is appropriate in my view to be moving a little more quickly. … I also think there is something to be said for front-end loading any accommodation one thinks is appropriate.” Since the markets had already priced in 0.50% for May, the only way to interpret Powell’s remarks is that there would be another 0.50% hike in June and possibly July as well.

Some analysts interpreted Powell’s remarks as a warning that a 0.75% hike might even be in the cards. This kind of tightening required markets to reprice their expectations and they did so in a hurry. The Dow Jones Industrial Average fell 981 points the day after Powell’s remarks and the NASDAQ and S&P 500 took similar dives in percentage terms.

Powell’s rate hike plan is intended to squash inflation currently running at over 8.5%. Powell’s problem is that in order to squash 8% inflation, he would have to raise rates to 10% in order to achieve a real rate of 2%. But, there’s no way Powell could get rates to 10% without a massive recession and market crash.

The market will probably crash before rates get to 5%, let alone 10%. The faster Powell raises rates, the sooner the crash will come. And that’s what spooked markets last Friday.

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