Wall Street plunges after Fed chair warns of pain from inflation fight

NEW YORK • Wall Street recoiled on Friday, after the Federal Reserve's stern warning that its campaign to lower inflation by raising interest rates is "unconditional" even if it leads to pain for households, businesses and, in turn, stock prices.

The S&P 500 fell 3.4 per cent, its worst daily showing since mid-June, taking its losses for the week to 4 per cent. The slump was broad, with all sectors of the index lower.

Bond investors also quickly adjusted for more rate increases from the Fed, with the two-year Treasury yield, which is sensitive to rising interest rates, moving close to its highest level of the year at 3.44 per cent, before easing back to 3.38 per cent.

"While higher interest rates, slower growth and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses," Mr Jerome Powell, the Fed chair, said during a speech at the Kansas City Fed's annual conference in Wyoming.

"These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain," he said.

The central bank is grappling with the task of guiding the US economy out of a pandemic, at a time when pent-up demand, broken supply chains and soaring energy costs have led to the fastest pace of price rises in a generation.

The Fed is expected to raise interest rates to their highest level since 2008, when officials meet next month, increasing borrowing costs for consumers and companies, and cooling the economy.

Investors had expected Mr Powell to caution that the central bank's task of fighting inflation was far from complete, after a host of other Fed officials communicated a similar message in recent weeks. In anticipation, they pulled nearly US$1 billion (S$1.39 billion) from funds that invest in US stocks for the week through Wednesday, data from EPFR Global shows. Funds that buy low-rated bonds, known as junk bonds, saw more than US$4 billion of withdrawals.

Still, the clarity of Mr Powell's comments on Friday removed any uncertainty about his intentions to make economic conditions more restrictive, said Mr Lee Ferridge, head of macro strategy for North America at State Street Global Markets. "This was not the Powell we normally see where he tries to be more balanced," Mr Ferridge said. "I don't see how you could take what he said any other way."

Such caution reflects a marked change of sentiment on Wall Street, where trading last month and early this month had been defined by a roaring market rebound, in part predicated on the idea that the Fed was about to start easing off its aggressive campaign to raise interest rates.

After plunging more than 23 per cent for the year through mid-June, the S&P 500 rallied over 17 per cent in the next two months.

After Friday's market moves, the index remains about 15 per cent lower for the year.

"Our responsibility to deliver price stability is unconditional," Mr Powell said.

However, some continue to question Mr Powell's conviction.

The central bank has stepped in to support financial markets on numerous occasions since the 2008 financial crisis.

Mr Andrew Brenner, head of international fixed income at National Alliance Securities, suggested that the Fed might come to investors' rescue again if its decision to maintain an extended period of higher interest rates damages the economy.

"I continue to not believe him," Mr Brenner said.

Trading in some corners of the financial markets offered signs that Mr Brenner is not alone in thinking the Fed may end up easing its campaign. Investors continue to bet on the Fed cutting interest rates next year, contrary to the central bank's own predictions.

NYTIMES