More rate hikes are expected

By: Miguel A. Rodriguez

10:39, 30 August 2022

Jerome Powell was much tougher in his statement than the market was anticipating

US stock indices continued lower on Monday, adding to last week’s sharp sell-off as investors fret over the Federal Reserve's plan to keep raising interest rates in their fight against inflation, even at the cost of an economic slowdown.


Powell did not hesitate to say that Fed would follow the path of a more restrictive monetary policy even if the economy could suffer a deep slowdown. He stated that the objective is for the unemployment rate to worsen soon to avoid a spiral of rising wages that would turn inflation into a structural problem for the economy. The Federal Reserve set the goal of monetary policy to achieve full employment after the pandemic crisis. Now that they have succeeded, it seems this is a problem, at least deduced from Powell's statements.


The markets reacted dramatically lower, and the US Dollar strengthened against all its peers. This creates an additional problem beginning to impact emerging countries that do not export raw materials financed in US Dollars and see how their currencies collapse. This scenario applies to India, which has been forced to intervene in the market to stop the fall of its currency.


But as has been the case recently, the fixed-income market seems not to believe these statements by the Fed, and the Treasury Bond yields, especially the longer duration references, practically did not move since Friday. The US 10-year bond yield is 3.11%, up a few basis points from last week.


The Treasury bond market is betting that aggressive action by the Fed will push the economy into a recession and be forced to reverse it quickly. On the other hand, inflation data is giving clear signs of peaking and is retreating, pointing to a change in bias at the next Fed meeting.


Meanwhile, the stock indices remain under downward pressure pending the publication of the non–farm payrolls this Friday. The metrics will be relevant for the market because if it continues to show strength, it could worsen the situation by confirming Fed’s aggressive monetary policy. Good news becomes bad news in this case.


The US Dollar remained strong yesterday, pushing the Euro down around the parity zone. Most market analysts expect the EUR/USD pair to continue to be bearish. Shortly, it will approach the 0.9900 area, which will pressure the European Central Bank to raise interest rates more decisively.


Sources: Bloomberg, Reuters

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