Stocks tumble as Powell signals inflation is ahead

US stocks tumbled Thursday after Federal Reserve Chairman Jerome Powell predicted an increase in consumer prices this summer — something investors fear will force interest rates up sooner than expected.

Powell, speaking at a conference Thursday, predicted strong job growth and increases in consumer prices as the vaccine rollout allows the economy to reopen fully. But he cautioned the Fed does not think the economy is at risk of overheating.

Still, the market reacted strongly to his interview. The 10-year US government bond yield jumped and was up 0.07% at 1.54% around the time of the closing bell.

Meanwhile, stocks sold off. The Dow (INDU) finished down 1.1%, or 346 points, and the S&P 500 (SPX) closed 1.3% lower.

The Nasdaq Composite (COMP) fell even more sharply, tumbling 2.1%. The index managed to just avoid dipping into correction territory — defined as a 10% drop from its most recent high -— as it was down 9.7% from its February 12 record high. The Nasdaq has erased its gains for the year.

“We do expect that as the economy reopens and hopefully picks up, we’ll see inflation move up,” Powell said during an interview at the virtual Wall Street Journal Jobs Summit.

“Compared to the economic scenarios we contemplated a year ago, it’s good to see where we are,” he said.

US inflation is currently below the Fed’s long-run target of around 2%. In fact, price increases have been rather low for a long time.

“For several decades the US and world economy has been in a low inflation world,” Powell said.

While an uptick in prices during the reopening is likely, it’s just as likely that these effects will be short lived.

“With long rates rising in response to his commentary, we are again seeing a market that is taking control of monetary policy from the Fed,” wrote Peter Boockvar, chief investment officer at Bleakley Advisory Group in a note to clients. He also called Powell “very dovish.”

“If we do see what we believe is likely a transitory rise in inflation […] I expect that we will be patient,” Powell said during the interview. “There’s a difference between a one-time surge in prices and ongoing inflation.”

But Powell is well aware of the perils of high inflation: “High inflation is a very bad state of affairs. It hurts people most on fixed incomes and lower incomes,” he said.

He added that various conditions would need to be in place for the central bank to increase interest rates, including getting the job market close to maximum employment and long-run inflation sustainably around 2%.

The timing of an interest rate hike will depend entirely on these conditions, Powell said.

The job markets won’t be fixed this year

As for the labor market — which is still short about 10 million jobs compared with February 2020 before the pandemic hit — improvements are coming, but the work isn’t done.

“There is good reason to expect job creation will pick up in coming months,” Powell said, but that doesn’t mean the labor market will be fully recovered come December.

“We haven’t succeeded in this yet but we’re right there. The next couple of month very important on the pandemic. If we keep making progress that’s what will help the economy,” the central banker said.

For example, the unemployment rate — currently at 6.3% — might not show whether the job market has recovered, considering that it doesn’t count the workers who have dropped out of the labor force altogether because of the pandemic. As a result, America has witness the sharpest drop in labor force participation in many decades, Powell said.

The Fed also wants to see wages moving up in a broad-based way. Average American paychecks have gotten fatter since the pandemic started, but that’s mostly due to the math: With many low-income workers unemployed, the average earnings have increased.

Powell took over at the helm of the central bank in February 2018, but his four-year term will come to an end next year. He declined to say whether he would like to serve a second term.