September 21, 2022: Fed raises interest rates by three-quarters of a percentage point

US stocks ended the day lower Wednesday following the news of a third straight three-quarters of a percentage point interest rate increase by the Federal Reserve. The move was not surprising, but Fed chair Jerome Powell strongly suggested that more big rate hikes are coming as the central bank continues to fight inflation. 

With the Fed's latest rate hike, the "pain" that Chair Powell has been warning about will take many forms, including job losses, which the central bank chief euphemistically calls "softening in the labor market."

Critics such as Senator Elizabeth Warren have repeatedly called out the risk of raising unemployment, which is currently near historic lows at around 3.7%. When interest rates go up, business activity slows, leading to less hiring and more layoffs. The Fed now expects unemployment to reach 4.4% next year, which would amount to more than 1.3 million jobs lost.

"Chair Powell just announced another extreme interest rate hike while forecasting higher unemployment," Warren tweeted. "I’ve been warning that Chair Powell’s Fed would throw millions of Americans out of work — and I fear he’s already on the path to doing so."

Powell reiterated in a news conference that the short-term pain is far preferable to the longer-term pain of letting inflation run rampant. Slower growth and higher unemployment "are all painful for the public that we serve, but they're not as painful as failing to restore price stability and having to come back and do it down the road again," he said.

To set the labor market up for another strong period, he added, we have got to get inflation behind us.

"I wish there were a painless way to do that. There isn't."

Curing inflation is like driving with a blindfold: You might not know that you're on the wrong path until you bump into something.

The Fed has a tool to combat high prices: Raising its target interest rate. But that historically works with a lag. So the Fed wants to keep hiking rates ... but cautiously so it doesn't inadvertently raise them too high and crash the economy.

"Changes in financial decisions begin to affect economic activity within a few months. But it's likely to take some time to see the full effect on inflation," Federal Reserve Chairman Jerome Powell said Wednesday. "So we are very much mindful for that. And that's why ... it will become appropriate to slow the pace of rate hikes while we assess how adjustments are affecting the economy."

My colleague, Nicole Goodkind, asked Federal Reserve Chairman Jerome Powell this afternoon to clarify what he means by a "reset" in the housing market.

Goodkind noted that existing home sales have fallen for seven months straight and mortgage rates are the highest since 2008, yet mortgage demand continued to increase and housing prices are still elevated.

"When I say 'reset,' I'm not looking at a particular, specific set of data or anything," Powell said. "What I'm really saying is that we've had a red-hot housing market all over the country where, famously, houses were selling to the first buyer at 10% above the ask before even seeing the house, that kind of thing. So, there was a big imbalance between supply and demand."

Powell said housing prices were going up at an unsustainably fast level. The "reset" should "help bring prices more closely in line with rents and other housing market fundamentals."

"That's a good thing," Powell said. "For the longer term, what we need is supply and demand to get better aligned so housing prices go up reasonably and people can afford houses again."

Stocks were all over the place Wednesday, alternating between gains and losses after Federal Reserve chair Jerome Powell continued to talk about the need to fight inflation. (We lost track of the number of times he discussed "price stability" as being job number one for the Fed.)

The Dow, which fell shortly after the latest rate hike was announced, surged at the beginning of Powell's press conference but was flat with less an hour to go before the closing bell. The S&P 500 rose about 0.4% and the Nasdaq gained 0.6%.

Investors are already preparing for another big rate hike in November. Federal funds futures listed on the CME are pricing in a more than a 70% chance of another three-quarters of a percentage point rate hike on November 2.

That would be the fourth consecutive hike of that magnitude and would bring rates up to a range of 3.75% to 4%.

Federal Reserve Chairman Jerome Powell said Wednesday that the Fed remains committed to getting inflation down to a healthy 2% annual growth. But, as Powell has said before, it will be painful getting there.

"To accomplish that, we'll need to do two things in particular: ... a period of growth below trend and softening in labor market conditions to foster a better balance," Powell said.

The Fed now expects the American economy will grind to a near halt this year, and the unemployment rate will rise a percentage point by then.

Federal Reserve Chairman Jerome Powell said Wednesday that the Fed will continue to hike rates as it looks to control inflation. But it can't raise rates forever without plunging the economy into a recession.

That's why Powell said the Fed will eventually have to pace out the rate hikes.

"We will be looking for compelling evidence that inflation is moving down, consistent with inflation returning to 2%. We anticipate that ongoing increases in the target range for the federal funds will be appropriate," Powell said. "At some point as the stance of policy tightens, it will be appropriate to slow the pace of increases while we assess how our policy adjustments affect the economy."

Stocks rose after Powell sounded that somewhat optimistic note. The S&P 500 and Dow were about flat, and the Nasdaq rose 0.2%.

The Fed's new projections show the growing risk of a hard landing, where monetary policy tightens to the point of triggering a recession. They also provide some proof that the Fed is willing to accept "pain" in economic conditions in order to bring down persistent inflation.

The higher prices mean that consumers are spending around $460 more per month on groceries than they were this time last year, according to Moody's Analytics.

Still, the job market remains strong, as does consumer spending. Housing prices remain high in many areas, even though there has been a substantial spike in mortgage rates. That means the Fed may feel that the economy can swallow more aggressive rate hikes.

The Fed's third consecutive three-quarters of a percentage point rate increase was widely expected. But what got markets moving was the so-called dot plot, which shows the projected target range for interest rates by the end of the year from all the Fed members. That went from 3.4% in June to an estimated 4.4% by the end of this year.

That suggests the next two meetings will include yet another 75-point hike and a 50-point hike. Wall Street was counting on a 100 basis points increase, not 125, and investors are notoriously averse to unexpected changes, even if it's just a couple dozen basis points.

All three major US equities indexes slipped after the Fed announcement.

"It will be really important to see if Powell blesses the dots and another 75 bps in November," wrote Peter Boockvar, chief investment officer for Bleakley Financial Group. "Either way, the Fed has now entered the ‘Danger Zone’ in terms of the rate shock they are throwing onto the US economy."