Federal Reserve Chairman Jerome Powell on Tuesday cleared the way for larger interest rate hikes at this month's central bank policy meeting, sending markets into a tailspin.
In his remarks to the Senate Committee on Banking, Powell said that economically painful interest rate hikes are "likely to be higher than previously anticipated," and that as a result, the labor market is also "very likely" to weaken.
Investors didn't take the news well, but some analysts think that's exactly what Powell wanted.
What's happening: Tuesday was a terrible day for markets. The S&P 500 fell 1.5%, the Dow dropped 575 points, or 1.7%, and the tech-heavy Nasdaq composite ended 1.3% lower.
Bond yields, meanwhile, surged as stocks fell. The 2-year Treasury yield nearly hit 5%, its highest level since 2007.
After Powell's testimony, market expectations for a half-percentage point rate hike spiked. At the start of Tuesday, investors were pricing in about a 30% probability for a half-point rate hike later this month. By market close, that probability had grown to 70%, according to the CME FedWatch Tool.
Keeping expectations in check: Citing a glut of strong economic data and hot inflation reports, Powell said in his testimony to Congress that the promising disinflation seen late last year had ebbed. If inflation fails to continue falling, he said, the Fed will keep trying to cool things down by raising rates.
Powell simply can't afford to sound dovish on inflation given how strong January's price data was, noted Tom Graff, head of investments at Facet.
Even if Powell was sure that January's economic data was a fluke, he still wants to maintain the Fed's credibility. Appearing dismissive of the recent uptick in inflation could harm the public's trust in the central bank, he added.
Investors aren't celebrating, but Powell is likely satisfied with his work Tuesday, said Jamie Cox, managing partner for Harris Financial Group. That's because market rallies help to expand the economy, which is the opposite of what the Fed is trying to do with its tightening policy.
"Powell wants to keep forward guidance in check so the market doesn't unwind the Fed's work to keep monetary conditions tight," said Cox.
Interest rates may be sitting at recent highs but stock valuations still remain strong. Policymakers noted that they were particularly worried about that disconnect, according to the most recent Fed minutes.
Fed officials suggested in those meeting notes that investors were too confident that inflation had peaked and that the Fed would soon pivot away from rate hikes.
What's next: On Wednesday, Powell will continue his two-day trip to Capitol Hill and testify before the House Financial Services Committee. Investors will be watching to see if the Fed chair doubles down on his hawkish comments and if he makes any attempts to directly address Tuesday's market plunge.
The House of Representatives can be a bit more spirited than the Senate in its line of questioning, so there may be some tension between fiery lawmakers and Powell.
Beyond Wednesday, investors will be evaluating several key pieces of data set to be released ahead of the next Fed policy meeting. Reports on jobs, retail sales and inflation are all due out ahead of the next rate hike decision.
"The Fed is data dependent, so inflation is still a wild card and the next round of hikes are yet to be determined," said Jeffrey Roach, chief economist for LPL Financial.
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