WASHINGTON, Jan. 31 (Xinhua) -- U.S. stocks closed higher on Monday, but still posted their worst monthly performance since the onset of the COVID-19 pandemic, as the Federal Reserve shifts to a more hawkish stance on inflation and investors brace for multiple interest rate hikes this year.
U.S. STOCKS EXTEND SELL-OFF AMID HAWKISH FED
The S&P 500 index fell 5.3 percent in January, its worst monthly performance since the pandemic took hold in March 2020 and biggest January decline since 2009.
The tech-heavy Nasdaq Composite index fell nearly 9 percent in January, its largest one-month decline since March 2020. Meanwhile, the Dow Jones Industrial Average ended the month down 3.3 percent.
Analysts said the biggest driver of the recent decline in U.S. stock markets is the Fed's intention to reduce monetary support, which has artificially boosted stock prices for years.
The Fed signaled last week that the central bank is ready to raise interest rates as soon as March to combat surging inflation as it exits from the ultra-loose monetary policy enacted at the start of the pandemic.
"We're prepared to use our tools to assure that higher inflation does not become entrenched," Fed Chair Jerome Powell said last Wednesday at a virtual press conference following a Fed policy meeting, adding "there's quite a bit of room to raise interest rates without threatening the labor market."
Powell did not rule out the idea of raising rates at every policy meeting this year, which would amount to seven increases in 2022. However, Fed officials' median interest rate projections released last December forecast just three rate hikes this year.
The Fed's more hawkish-than-expected stance has rattled global financial markets, leading to a sell-off in U.S. stocks and bonds, as well as a strengthening U.S. dollar. Now traders have priced in a total of five quarter-point rate hikes this year.
"I am personally not surprised by the sell-off that we are seeing in the marketplace, but how much further of the sell-off we are going to see, I think that is an open question," said Tobias Adrian, financial counselor and director of the International Monetary Fund's Monetary and Capital Markets Department.
With U.S. inflation well above the Fed's target and the unemployment rate now below estimates for the level equivalent to maximum employment, "financial conditions need to be tightened to some degree," Adrian told Xinhua in a recent interview.
"I think the question is not whether financial conditions should tighten, but what the right degree is of tightening. It's a question of magnitude," he said.
Desmond Lachman, resident fellow at the American Enterprise Institute and a former official at the IMF, believed that the Fed needs to enact at least four rate hikes this year to cool inflation down.
"The Fed did shift to a more hawkish monetary policy stance and recognized that the country has an inflation problem. However, it is yet to raise interest rates from the zero bound despite the fact that inflation is running at almost three times its target. This means that the Fed remains behind the inflation curve," Lachman told Xinhua.
"However, there is the risk that those rate increases could cause the stock market bubble to burst, in which case the Fed might become more dovish and not raise interest rates as much as it currently envisages," Lachman said.
The Fed has pledged to keep its federal funds rate unchanged at the record-low level of near zero since the onset of the pandemic, while U.S. inflation has become higher and more persistent in recent months.
The personal consumption expenditure price index, the Fed's preferred inflation measure, jumped 5.8 percent in December from a year ago, the fastest annual pace since mid-1982 and well above the Fed's target of 2 percent, according to the U.S. Commerce Department.
ADD TO EMERGING-MARKET HEADWINDS
A more hawkish Fed is also expected to prompt tighter global financial conditions and add to headwinds for emerging markets, which are already grappling with slowing growth, higher inflation and record debt, analysts said.
In an update to its World Economic Outlook report released last week, the IMF expected emerging market and developing economies to grow by 4.8 percent this year, down by 0.3 percentage points from the previous forecast.
"Spillover effects to emerging markets from the policy normalization process in advanced economies could result in a marked rise in real rates. Such further tightening of domestic financial conditions at a time of high fiscal deficits and external financing needs could generate significant strains, putting the nascent growth recovery at risk," the IMF warned.
"Those emerging markets that are somewhat weaker would certainly be relatively more affected by a tightening of global financial conditions," Adrian said, adding higher real interest rates with higher public debt could lead more countries into distress.
"On the whole, the emerging markets are very much more indebted today than they were in the earlier cycle and many of them have large budget deficits. This makes them at least as vulnerable to a Fed tightening cycle as in the previous one," Lachman said.
"There would seem to be no question that in the context of rising U.S. interest rates and a strong dollar, we will see a large increase in emerging market debt defaults over the next year," he said.
Petya Koeva Brooks, deputy director of the IMF's Research Department, told Xinhua that clear policy communication by the Fed will be particularly important to "minimize the risks of adverse spillovers."
"When you know what is coming, it is much easier to be ready for it and to prepare for it," Brooks said. "We are in an unprecedented situation. So it is good to be ready." ■