Wall Street is terrified of the end of the easy money, as evidenced by the Nasdaq selloff ahead of the Federal Reserve Chairman Jerome Powell's testimony in front of the Senate Banking Committee on Tuesday morning.
Investors and traders have been concerned that the Fed will end its easy money policy as the economy shows signs of improvement and inflation is coming back.
According to government data published last week, the Producer Price Index—a measure of the average change over time in the selling prices received by domestic producers for their output—increased 1.3% in January and 1.7% on a year-over-year basis. It's a big jump from 0.8% in December and a big turnaround from last summer when PPI was hovering in negative territory.
The tech-heavy Nasdaq lost more than 5% on Monday and early Tuesday morning before regaining some of these losses late Tuesday afternoon after Powell reassured the market that there will be no change in the central bank's policy.
Powell reiterated the position he took back in January, following the Federal Open Market Committee meeting: while the U.S. economy is improving, inflation is expected to stay tame in the near-term due to the slack in the labor markets.
Currently, at 6.3%, the unemployment rate is well above what economists call "natural rate," a threshold that could trigger inflation once crossed.
Meanwhile, capacity utilization—a measure of how busy factories are—is currently standing at around 75%, well below the 85% threshold that is considered full-capacity- a milestone that could fuel inflation once crossed.
Why all this anxiety in Wall Street, then? Because the Fed has upped the game. Monetary easing isn't confined to conventional cuts in short-term rates to help the economy recover from short and shallow contractions. It extends to reductions in long-term interest rates to help the economy avoid a prolonged stagnation. They do that by buying long-term securities like Treasury bonds and mortgages.
Ten months ago, for instance, the Fed launched an aggressive monetary easing that included cutting short-term interest rates to near zero and a $120 billion bond-buying program. It announced it will keep these measures in place until the economy resumes growth and unemployment reaches its target level.
While helping the economy, these policies raise investors' and traders' risk appetite as they search for higher returns in all sorts of speculative investments.
We'll know what happens to these investments when the Federal Reserve changes course and investors run for cover.
Read more here:
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- 2 Red Flags for the Hot US Housing Sector
- 4 Scenarios About Inflation
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