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Why Did Financial Markets Plunge After This Powell Announcement?

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FINANCIAL MARKETS in the United States dropped precipitously following confirmation by Federal Reserve (FED) Chairman Jerome Powell that the central bank plans to continue raising interest rates to contain inflation.

Raising interest rates “will bring down inflation, they will also bring some pain to households and businesses,” Powell admitted at the central bankers symposium in Jackson Hole, Wyoming. “Those are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain,” he added.

A rise in benchmark interest rates implies an increase in the cost of credit in the economy. The first to be impacted are credit cards, whose interest rates rise almost immediately after the Fed raises interest rates.

New mortgages for housing, cars or even student loans also tend to become more expensive as interest rates rise.

The purpose of raising interest rates is to slow down consumption in the economy, which has an impact on business income and ultimately on people’s jobs. If consumption slows down, in theory prices should stop growing at such a rapid rate.

In June, the Fed enacted the highest interest rate hike in 40 years, at 0.75%, and replicated the aggressive hike again in July.

Fed officials indicated that they plan to continue with interest rate increases, however, they will not be as aggressive as the hikes enacted in the summer.

Rising interest rates are beginning to show their impact on the economy, with the Commerce Department noting that consumer spending is slowing rapidly and during July grew by only 0.1% compared to 1% growth during June.

What are the financial markets afraid of?

Financial markets dropped precipitously after Powell’s announcement. The S&P500 stock index, which groups the main 500 U.S. corporations, fell by 3.37%.

The Dow Jones index fell 3.03%, while the technology index, Nasdaq, fell 3.94% on account of Powell’s announcement.

With a reduction in consumption, companies expect lower sales and, consequently, investors expect lower returns for their portfolios.

Despite financial market concerns, the Fed has signaled that it plans to continue raising interest rates well into 2023.

At present, benchmark interest rates are between 2.25% and 2.5%; by the time the Fed’s tightening ends, rates could have risen to as high as 3.5%.

The interest rate hike may deepen the recession in the United States, which is experiencing high inflation, low unemployment, but little or no negative growth.

The Biden administration and the Democratic Party have sought to counter the low growth situation by stimulating demand through government spending, announcing two massive new spending plans: the Inflation Reduction Act and the forgiveness of up to $10,000 in student debt.

Both programs would inject hundreds of billions into the economy which could potentially reheat the economy undermining the Fed’s efforts to control inflation.

Some bankers are skeptical about the ability they have to control inflation, as is the case of the President of the European Central Bank (ECB), Christine Lagarde, who has stated that “we will not go back to that environment of low inflation.”

Despite the skepticism of his ECB counterpart, Powell remains firm in his stance to control rising prices: “The longer the current bout of high inflation becomes entrenched, the greater the chance that expectations of higher inflation will become entrenched,” he explained at the central bankers’ symposium.

Economist, writer and liberal. With a focus on finance, the war on drugs, history, and geopolitics // Economista, escritor y liberal. Con enfoque en finanzas, guerra contra las drogas, historia y geopolítica

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