Stock Market Dips May Be on Horizon as Feds Look to Interest Rate Hikes to Curb Inflation

The United States Senate Banking Committee held a hearing today where lawmakers spoke with Federal Reserve Chair Jerome Powell about what actions he might take to bolster America's economy ahead of his expected re-nomination for a second term as chair of the country's central bank.

During this hearing, senators focused on what Powell would do to address an inflation rate that jumped by a historic 6.8 percent over the past calendar year. To this, the chair provided the committee with the following statement:

"I would expect that this year, 2022, will be a year in which we take steps toward normalization," Powell said. "That would involve raising the federal funds rate. That would involve ending asset purchases in March, and perhaps, later this year, depending on the run of things, we would also see ourselves beginning to allow the balance sheet to shrink."

This move represents a shift away from the early pandemic policy of promoting monetary expansion by encouraging consumers to spend and businesses to invest, Itay Goldstein, an economics professor at the Wharton School of the University of Pennsylvania, told Newsweek.

Goldstein said that with these changes could come a likely dip in the stock market as investors become less rosy on the state of the market as companies are forced to borrow at higher interest rates. They could also see a decrease in the amount of federal dollars being pumped into the private sector through Fed asset purchasing, the buying of securities. Just how deep this dip will plunge, Goldstein said, depends on both the Fed and the Biden administration's handling of the matter.

President Joe Biden could soon face heat as he may trade the issue of inflation for the issue of a declining stock market. Here, he prepares to sign the Paycheck Protection Program (PPP) Extension Act of 2021 into law at the White House in Washington, D.C., on March 30, 2021. Photo by JIM WATSON/AFP via Getty Images

"You can think about it as if they're flying a plane and now, they want to land the plane but don't want it to be a sort of a bumpy ride," Goldstein told Newsweek. "They're preparing everyone for what's coming because the concern is that if they do something too abrupt and all of a sudden the stock market drops dramatically in a matter of a few days, that would be unhealthy to the economy that is going to lead people to panic and suffer losses."

Avoiding the type of panic that could trigger the type of selloffs that would rock the market requires the government to manage perceptions around the upcoming changes. So far, the managing of perceptions around the economy has been a challenge for the Biden administration.

While a number of prominent economists tied to some of the nation's preeminent institutions have praised the Biden administration's performance in pushing for a rapid recovery amid the March recession and keeping both the stock market and household spending stable since 60 percent of voters still disapprove of the president's handling of the economy.

Gary Burtless, an economist with the Brookings Institution, told Newsweek that in regard to that matter, voters often judge performance by where they're hurt most—In this case, by the inflation-related surge in gas and grocery prices.

Goldstein said that if inflation rates do fall as a result of Powell's aforementioned measures, the administration will likely see that heat redirected toward a potential dip in the stock market. At the end of the day, the nation will continue to face issues tied to the pandemic and the effects it will continue to have on the global economy. As the Biden administration moves forward, its success will hang on its ability to balance future economic obstacles, whether it be inflation or falling stock values.

"The steps that they need to take in order to bring inflation down are going to hurt the stock market and then potentially directly hurt the real economy with hiring, investments, and so on. It's really just finding the path that is going to cause the least accumulative damage," Goldstein told Newsweek. "It's a highly sort of treacherous road ahead."