US stocks fall on Powell warning of bigger rate increases

Stocks in New York declined and the dollar rallied on Tuesday after Federal Reserve chair Jay Powell warned the central bank could more aggressively raise interest rates if the US economy grows too quickly.

In testimony to lawmakers in Washington, Powell warned that if economic data indicated “that faster tightening is warranted, we would be prepared to increase the pace of rate hikes”.

Wall Street’s benchmark S&P 500 fell 0.5 per cent and the tech-heavy Nasdaq Composite dropped 0.3 per cent following his comments.

The Fed lifted borrowing costs by a quarter percentage point at the start of February, looking to slow the pace of rate rises after a series of aggressive increases last year designed to curb surging inflation.

A flurry of strong economic data since the start of February suggested that inflation may prove stickier than previously expected. Investors have responded by upping their expectations for where interest rates might peak.

Powell’s comments constitute “a rare admission that the Fed made a mistake” by slowing the pace at which it raised rates over the winter, said Steven Blitz, chief US economist at TS Lombard. The Fed will probably revert to raising rates by 0.5 percentage points when it next meets if February’s jobs numbers, out on Friday, confirm that the US economy remains in relatively rude health, Blitz added.

The dollar strengthened on the prospect of more monetary policy tightening, gaining 1 per cent against a basket of six international peers. Futures markets now expect US rates to peak at about 5.57 per cent in September, up from 5.47 per cent in the same month before Powell’s remarks.

Short-term US government bonds sank on the day, with the yield on the interest rate-sensitive two-year Treasury rising 0.08 percentage points to 4.97 per cent, having been at 4.1 per cent at the start of February. In contrast, the yield on the benchmark 10-year Treasury fell 0.04 percentage points to 3.94 per cent.

The diverging moves in Treasuries signal that markets expect the Fed “is going to have to cause a recession to bring inflation under control”, said Lyn Graham-Taylor, senior rates strategist at Rabobank.

European stocks mostly declined on Tuesday, with the region-wide Stoxx 600 down 0.8 per cent. London’s FTSE 100 declined 0.1 per cent.

Chinese equities also slipped after disappointing trade data added to investors’ concerns that the country’s post-zero Covid recovery might prove less explosive than previously expected.

China’s CSI 300 fell 1.4 per cent and Hong Kong’s Hang Seng index lost 0.3 per cent after imports in January and February declined 10.2 per cent compared with the same period a year earlier. Exports fared better, falling just 6.8 per cent. Analysts had expected declines of 5.5 per cent and 9.4 per cent for imports and exports, respectively.

“Either reopening has yet to provide much support to import demand, perhaps because many consumer-facing services are not import intensive, or any boost has been offset by a further drop in imports for processing and re-export,” said Julian Evans-Pritchard, senior China economist at Capital Economics.

Imports are expected to pick up later in the year, Evans-Pritchard added, but the better than forecast export figures “may drop back again before long as the one-off boost from easing virus disruptions fades” and foreign demand cools.

Tuesday’s Chinese trade figures came after outgoing premier Li Keqiang earlier this week told the annual National People’s Congress that the aim for economic expansion for 2023 was “around 5 per cent” — the country’s lowest growth target for more than three decades.