Powell Doesn’t Have to Go Full Volcker for Stocks to Drop

Rhetoric emanating from the Federal Reserve hasn’t been so hawkish in decades. Investors, especially in stocks, are probably too complacent. 

The Fed on Wednesday raised the benchmark federal-funds rate by three quarters of a percentage point, to a range of 3% to 3.25%, as expected. Fed policy makers’ projections for rates at the end of this year also rose: Their median forecast is now that the federal-funds rate will reach 4.4% by then.

This implies more hikes at each of the Fed’s two remaining meetings, at least one of which would need to be three quarters of a point. This again was more or less in line with what was already priced into futures markets.

At Fed Chairman

Jerome Powell’s

press conference, he highlighted some signs that the economy is slowing. Mr. Powell also said that inflation expectations appear to be “well anchored,” though he warned this is “not grounds for complacency.”

But investors should probably focus less on Mr. Powell’s comments Wednesday and more on his speech at Jackson Hole, Wyo., on Aug. 26, where he telegraphed his intentions clearly. Evoking the legacy of

Paul Volcker,

the Fed Chair who crushed inflation at the cost of a deep recession in the early 1980s, he was blunt about the trade-offs ahead.

“Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions,” Mr. Powell said in August. He reiterated that on Wednesday, using nearly identical language. 

This is key. The hope of many investors is that, as oil and other commodity prices come down, the Fed might soon see fit to ease up, possibly guiding the economy to a soft landing. But, as TS Lombard economist

Steven Blitz

argues, under current conditions that is unlikely to be enough. 

The Federal Reserve approved its third consecutive interest-rate rise of 0.75 percentage point as the central bank continues to fight high inflation. Photo: Sarah Silbiger/Bloomberg

“Falling gasoline prices only add fuel to an economy already running hot with unemployment below 4%,” he wrote in a recent note. Hence the Fed’s clear signaling that we may need to see some weakness in the labor market. 

In his comments Wednesday, Mr. Powell described the labor market as “extremely tight” and “out of balance,” with demand for workers outstripping supply. This isn’t the 1980s, and the inflation Mr. Powell is contending with isn’t nearly as entrenched as that of the 1970s. A recession therefore isn’t a sure thing and, if there is one, it might not be very deep or prolonged by historical standards.

But it is quite clear that the Fed still wants to see the economy slow significantly from where it is now, even if that involves some pain for American companies and households. 

This suggests that markets remain a little too comfortable. As of Wednesday’s close, the S&P 500 was down 9.7% since the Jackson Hole speech. It is still up 3.4% since the June lows, when recession fears were at their peak. Those lows could easily be revisited. 

Write to Aaron Back at aaron.back@wsj.com

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