Stock Markets Fall After Fed Rally Fades – The New York Times

On Wednesday, investors took comfort that the Federal Reserve would do whatever was necessary to bring inflation to heel, responding to the rallying cry of the Fed chair, Jerome H. Powell, by pushing stock prices up.

A day later, reality sank in.

Stocks tumbled on Thursday as investors came to terms with what the Fed’s tougher stance meant for the economy: higher interest rates and the growing likelihood of a recession.

The S&P 500 closed down more than 3 percent, part of a global retreat that saw stocks in Europe also post sharp declines as central banks in other countries raised rates. With Thursday’s decline, the S&P 500 is now almost 24 percent below its Jan. 3 peak, plunging deeper into the bear market that officially began on Monday.

If stocks continue to fall over the next two weeks, the three-month period that ends June 30 could ultimately be the index’s worst quarter since 2008, when the collapse of Lehman Brothers set off the global financial crisis.

The plunge reflects a stark reality for corporations and their shareholders: The fastest inflation in four decades is sapping the buying power of consumers and driving up the cost of materials, transportation, labor and everything else that goes into running a business. But the Fed’s efforts to fight it might, at least in the short term, prove even worse: By raising rates, the Fed hopes to cool demand enough to tamp down inflation — but the risk is that it does too much, tipping the economy into a recession.

“Inflation is not going to come down anytime soon, and it is going to take some kind of slowing of the economy for that to happen,” said Jay Bryson, chief economist for Wells Fargo. “It’s a really tricky situation.”

Until this week, Mr. Bryson and his team were still betting that the United States could avoid a recession. But after yet another faster-than-expected inflation report on Friday, and the inevitability that the Fed would get more aggressive as a result, they capitulated: On Wednesday, moments after Mr. Powell finished speaking, Wells Fargo sent a note to clients predicting that a recession would start next year.

The Fed on Wednesday announced its largest rate increase in decades. It was a forceful — if, in the view of some economists, belated — effort to rein in inflation that has proved more severe and more persistent than most forecasters predicted a year ago. Other central banks are following suit: The Bank of England announced on Thursday its fifth consecutive interest rate increase, and Switzerland’s central bank raised its interest rate for the first time in 15 years, a more aggressive move than many expected.

Europe’s Stoxx 600 index fell 2.5 percent, its seventh decline in eight days. The FTSE 100 in London dropped 3.1 percent. The S&P 500 fell 3.3 percent. The concern on Thursday was evident outside the stock market, too. Copper and oil prices, which historically serve as measures of sentiment about the global economy, traded lower.

Policymakers hope that by raising the cost of borrowing for consumers and businesses, they can reduce demand for goods and services and buy time for supply chains and labor markets that have been disrupted by the pandemic to return to normal.

But bringing down demand, inevitably, means causing economic pain. If consumers want fewer goods and services, businesses will have less revenue and will need fewer employees, meaning slower wage growth and, in all likelihood, more layoffs.

There are hints that the recovery, until now among the strongest on record, is losing momentum. The once red-hot housing market has cooled rapidly as mortgage rates have risen. Fresh government data showed that builders in May broke ground on the fewest new homes in more than a year.

Average mortgage rates have nearly doubled this year, to about 5.8 percent on Thursday, from just over 3 percent. Consumers can also expect to pay more on credit card debt, car loans and certain student loans.

And retail sales fell in May for the first time this year as sky-high gas prices and rising borrowing costs ate into consumers’ budgets. The bear market is likely to worsen consumers’ dismal attitudes.

“Already, households have been squeezed by incredibly high inflation,” said Beth Ann Bovino, chief U.S. economist at S&P Global. “You just have to go to take your car to the gas station and feel the pain. That means that those high prices, both particularly with food and fuel, mean that a lot of people’s paychecks are going into essentials, very little is left to spend elsewhere. People are feeling the pain and are frustrated by it.”

Forecasters have steadily marked down their outlook for economic growth in the months ahead. IHS Markit on Thursday estimated that gross domestic product grew at an annual rate of just 0.8 percent in the current quarter; last week, they were calling for a 2.4 percent growth rate. A forecasting tool from the Federal Reserve Bank of Atlanta has an even more pessimistic prediction: 0.0 percent.

Such grim forecasts offer the possibility that the economy could end up shrinking this quarter for the second time in a row — a common, though unofficial, definition of a recession. The National Bureau of Economic Research, the country’s semiofficial arbiter of when business cycles begin and end, offers a more nuanced definition of a recession, calling it “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” Most economists agree that, by that definition, a recession has not yet begun.

Mr. Powell on Wednesday argued, as he has in the past, that the Fed can bring down inflation without causing a recession, although he acknowledged that its ability to do so depends on factors that are outside its control, such as gas prices, the pandemic and the war in Ukraine. Many analysts are skeptical that such a “soft landing” is realistic. After Mr. Powell’s comments, economists at Deutsche Bank called such hopes “overly optimistic.”

Even if the Fed succeeds, however, that doesn’t guarantee a quick recovery for markets. Inflation is likely to come down only slowly. Fed officials themselves think it will remain elevated at least through the end of the year. The economy, however, could slow relatively quickly. Europe, which was experiencing slower growth even before Russia invaded Ukraine and has been hit even harder by the spike in energy prices, is particularly vulnerable to such a period of “stagflation” — a portmanteau of the words stagnation and inflation, used to describe periods of high unemployment and rising prices.

Analysts say the stock market isn’t likely to regain its footing until there are clear signs that inflation is starting to come under control, which in turn would take pressure off the Fed to raise rates quickly. Stocks briefly rallied in late May, ending a seven-week losing streak, as data seemed to show that gains in consumer prices had peaked. But the selling began again last week after a new report on the Consumer Price Index showed that inflation accelerated again, jumping 8.6 percent in May from a year earlier.

“Not until it is clear that the U.S. has seen peak inflation are concerns about the trajectory of Fed hikes likely to ease significantly,” Jane Foley, a strategist at Rabobank, wrote in an email. “Meanwhile, the market sentiment is likely to remain scarred.”

The last time the Fed had to raise rates rapidly to control inflation, in the late 1970s and early 1980s, it caused what was at the time the worst recession since the Great Depression. But economists are optimistic the pain this time won’t be nearly as severe, partly because inflation hasn’t yet become endemic.

Still, Mr. Bryson noted that recessions, once they begin, often prove hard to escape.

“Knock on wood you don’t have to go through the same depth of a recession that we did in ’81, ’82 to wring inflation out of the economy today,” he said. “The problem though is the stresses of an economic downturn often bring out imbalances that up until that time were largely undetected.”

Jason Karaian contributed reporting.