Federal Reserve Rate-Hike Odds Slide As Stock Market Tumbles Ahead Of Powell Testimony

Commodities prices for oil, aluminum, steel, nickel, palladium, wheat, corn and soybean oil continued to surge on Tuesday, as financial markets braced for possible disruption of key supplies from Russia and Ukraine. As the inflationary effects of Vladimir Putin’s Ukraine invasion become clearer, Federal Reserve chief Jerome Powell is set to testify before Congress on Wednesday and Thursday at 10 a.m. ET.

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With inflation already running so hot and the Fed so far behind the curve, there’s concern on Wall Street that policymakers may feel little choice to not only plow ahead with rapid tightening, but potentially step up the pace of interest-rate hikes. Fed chief Powell may use his testimony to assuage that concern.

“The Fed tends to look past higher food and energy prices driven by geopolitical events and would, in our view, only be compelled to hike more aggressively if it sees signs of a wage-price spiral, which is not the case right now,” Solita Marcelli, chief investment officer in the Americas at UBS Global Wealth Management, wrote Monday.

Treasury yields plunged on Tuesday, with the 10-year yield diving 13 basis points to 1.71%, as investors sought safe-havens amid risk that the conflict could take an unpredictable turn. The two-year Treasury yield slid 15 basis points to 1.28%. The drop in Treasury yields also reflects the potential economic damage from higher inflation.

Powell’s main message to Congress — and Wall Street — likely will be that the Fed will stay flexible. That makes sense, given the hit to financial markets and uncertainty over supply disruptions.

Federal Reserve Rate-Hike Odds

Higher risk of disruption, following an escalation of sanctions on Russia over the weekend, triggered another leg down for the stock market on Tuesday, while crude oil futures surged 8% to $103.41 a barrel.

At the same time, markets pushed down odds of a 50-basis-point rate hike at the Fed’s March 15-16 meeting. The CME Group FedWatch tool now shows 0% odds of a half-point hike, down from about 40% a week ago. Now markets see a minor chance — about 10% — that the Fed won’t hike at all.

The big shift in market sentiment raises the importance of Powell’s testimony. What Powell has to say will shape Wall Street’s reaction to Friday’s jobs report.

If a 50-basis-point hike is still on the table, then a very strong jobs report would likely be viewed negatively by investors.

Economists expect Friday’s jobs report to show the addition of 390,000 jobs in February, as the unemployment rate eased back to 3.9%, after rising to 4% in January.

Meanwhile, the February consumer price index will be released on March 10.

Labor Market Risk

However, there’s one thing in the jobs report that might be really good news for markets: a surge in labor force participation as the pandemic recedes.

Vladimir Putin’s invasion of Russia is just the latest recent inflationary curveball for the Fed, following the delta and omicron variants. Yet the variants were fundamentally different. While reining in economic growth by slowing the services-sector recovery, they also fueled wage growth by shrinking the pool of potential workers, via early retirements, a spate of absences and childcare complications.

This latest crisis, from an economic standpoint, is all about price increases that will slow growth, though the extent remains to be seen. In that sense, it’s more of an unalloyed negative that the Fed might normally wait out. But if wage growth continues to remain red-hot, Fed policymakers could decide that they don’t have the luxury of patience.

Wall Street currently sees five rate hikes in 2022, lifting the Fed’s key rate to a range of 1.25%-1.5%. On top of that, the Fed has laid the groundwork for a partial reversal of its $4.5 trillion in Covid-era asset purchases.

The key question going into Powell’s testimony is what it will take for the Fed to alter course. Of particular interest: Will Fed policy be sensitive to financial market signals, such as the stock market correction or the flattening yield curve?

Bottom line: If Powell doesn’t indicate that Russia’s Ukraine invasion may be a game-changer for the Fed, Wall Street probably won’t respond well.

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