Stocks rise after the Fed takes historic action on inflation

US stocks jumped on Wednesday afternoon after the Federal Reserve announced it will increase interest rates by an aggressive three-quarters of a percent. 

Wednesday’s rate hike – the largest in 28 years – signaled to investors that the Fed is committed to lowering inflation rates. Fed chair Jerome Powell indicated that a similar hike could come in July if the economic data doesn’t improve. 

Stocks closely tied to economic outlook such as Boeing and the financials surged on the news. Tech stocks also grew. Amazon and Tesla both gained more than 5% on Wednesday.

As stocks settle after the trading day, levels might still change slightly.

A “game-changer” CPI report and the subsequent move by the Fed to turn increasingly hawkish have Wells Fargo economists changing their tune for 2023: Instead of a soft landing, expect a mild recession in the middle of the year.

The mild recession, which is anticipated but not assured, would likely resemble what the US economy saw in 1990 to 1991, economist Jay Bryson wrote in a note. That contraction lasted two quarters and saw a peak-to-trough decline in real GDP of 1.4%, Bryson wrote.

“There have been 12 US recessions since the end of the Second World War,” he wrote. “On average, these downturns have lasted four quarters with a peak-to-trough contraction in real GDP of 2.7%. So, our forecasted recession would be one of the milder downturns in the post-WWII era.”

And far less severe than the two most recent recessions (2007-2009 and 2020), which were “bruising affairs,” he noted.

“Because many of the underlying fundamentals of the economy are generally sound at present (i.e. household and business balance sheets are generally in good shape and the banking system is well capitalized), we think a mild and relatively short downturn is more likely than a deep and protracted one,” he wrote.

This time around, because the downturn would likely not be deep, the labor market shouldn’t fall apart; employers would be cautious about making massive cutbacks; and income shouldn’t decline significantly, he wrote, adding that receding inflation would likely spur the Fed to start cutting rates at the end of 2023.

One of the most shocking developments (at least to markets reporters/econo-nerds) from the Fed's rate hike announcement was the fact that Kansas City Fed president Esther George was the lone dissenter...and it's not because she wanted an even bigger rate hike.

George routinely has found herself named as one of the more hawkish members of the Fed, given that she typically is more worried about inflation than the Fed's so-called doves, who tend to prefer lower interest rates to keep the job market healthy.

But according to Wednesday's statement, George apparently preferred to raise rates by only a half of a percentage point, or 50 basis points.

The move is a bit of a surprise. But George has recently hinted that she might be amenable to slower rate hikes.

In a speech in May, she noted that the Fed is preparing to unwind its massive balance sheet, a move known as quantitative tightening that will be happening "with financial markets far more unsettled currently than in 2017," the last time the Fed wound down its balance sheet this dramatically.

George, who was appointed president of the Kansas Fed in 2011, last month said she plans to retire from the job in January 2023.

The big doubt economists have about the Fed's aggressive action on inflation: the central bank's ability to raise rates without crashing the US economy into a recession.

Federal Reserve Chairman Jerome Powell had been bullish on his chances to navigate toward that so-called soft landing. Now, he's not so sure.

"I don't want to be the handicapper here," Powell said. "This is our objective and I do think it's possible. Like I said, though, I think that events of the last few months have raised the degree of difficulty and created great challenges."

Powell said the chances of a soft landing are eroding because of factors outside of his control, including Russia's invasion of Ukraine, Covid and the supply chain crunch.

"Can we still do it? There's a much bigger chance now that it'll depend on factors that we don't control, which is, you know, fluctuations and spikes and commodity prices could wind up taking that option out of our hands," Powell said. "So we just don't know."

Federal Reserve Chairman Jerome Powell said the central bank is mindful of the dangers of raising rates too high, too quickly -- an action that some economists said could crash the US economy into a recession.

But Powell said he has a more pressing concern: losing control of prices.

"The worst mistake we could make would be to fail, which is not an option," Powell said. "We have to restore price stability. We really do, because it's the bedrock of the economy."

Without price stability, Powell said, the economy won't function properly.

"It won't work for people," he said. "Their wages will be eaten up, so we want to get the job done."

The Fed's policy statements included a key line in past months that the central bankers removed this month: "We believe that appropriate monetary policy effectively, alone, can bring about the result of 2% inflation with a strong labor market."

By taking that sentence out, the Fed is making a significant but accurate admission: Inflation isn't completely within its control.

"So much of it is really not down to monetary policy," Federal Reserve Chair Jerome Powell said at his press conference Wednesday. "That just didn't seem appropriate, so we took the sentence out."

Powell noted that the consequence of Russia's invasion of Ukraine, for example, is raising fuel and commodities prices to new records -- something the Fed cannot change.

"That's not something we can do something about," Powell said. "Appropriate monetary policy alone cannot reduce inflation, so much of it is not about monetary policy."

Like most observers, the Fed had expected that its half-point rate hike last month would help bring inflation down somewhat. Instead, the Consumer Price Index in May showed inflation rose at a 40-year high. And consumer sentiment fell to an all-time low.

"It was quite eye-catching and and we noticed that," Powell said, noting that it changed the Fed's plan to again raise rates by a half-point this month.

Still, Powell noted that many inflationary pressures remain outside the Fed's control, including high oil prices, supply chain constraints and Covid.

"What’s becoming more clear is that many factors that we don’t control are going to play a significant role in whether it’s possible to bring inflation down or not," Powell said. "But having said that, there is a path for us to get there, it’s not getting easier, it's getting more challenging because of these external forces."

Yet he said he's hopeful the Fed can raise rates without sinking the economy into a recession.

"We don't seek to put people out of work, of course," Powell said. "We don't think too many people are working. But we also think that you really cannot have the kind of labor market we want without price stability."

So much for selling on the Fed's rate hike news.

Stocks surged to their highest levels of the day after Jerome Powell suggested that people should not expect that many more rate hikes as large as the one just announced.

The Dow was up nearly 300 points, or about 1%. The blue chips had surged as much as 400 points at the beginning of his press conference. The S&P 500 and Nasdaq also added to their gains, rising 1.3% and 2.3% respectively.

Powell did not rule out the possibility of another 75 basis point hike in July. But he added that moves of this size would not be "common."

Federal Reserve Chair Jerome Powell sought to reassure investors and all Americans that the central bank understand its awesome responsibility to get prices under control.

The Fed "has the tools we need and the resolve it will take" to bring sky-high inflation back to normal, Powell said at the beginning of his remarks Wednesday.

"In the current highly unusual circumstances with inflation, well above our goal, we think it's helpful to provide even more clarity than usual," Powell said.

Powell noted that after the Consumer Price Index showed inflation returning to a 40-year high in May, the Fed was poised to act fast.

"The question is, 'what do you do? And do you wait six weeks to do it at the next meeting?" Powell said. "And I think the answer is that is not where we are with this. So we decided we needed to go ahead."