Newly installed Federal Reserve Chairman Jerome Powell says he and other Fed members are watching inflation closely and will hike interest rates as needed this year to keep it under control.
The stock market took that to mean that there is a possibility of four or more rate hikes in 2018, not the three that have been priced into stocks.
As Powell made those comments to the House Financial Services Committee, stocks plunged in a broad sell-off, with the Dow Jones Industrial Average closing down nearly 300 points.
Powell's comments might have spooked investors, but they held some good news for consumers. The new Fed Chairman said the economy is doing very well -- so well that rates might have to rise a little more than anticipated.
Brake pedal on the economy
The Federal Reserve uses its discount rate as sort of a brake pedal on the economy. When the economy begins to heat up, prices tend to rise. While some inflation is good, the Fed will raise rates to keep inflation from rising too much.
"The economic outlook remains strong," Powell told lawmakers. "The robust job market should continue to support growth in household incomes and consumer spending, solid economic growth among our trading partners should lead to further gains in U.S. exports, and upbeat business sentiment and strong sales growth will likely continue to boost business investment."
But Powell says the new tax law, passed in December, is adding stimulus to an already healthy economy. That could make the economy grow even faster and make inflation more of a threat. If it does, he says the Fed will respond accordingly.
Rates rise slowly
When the Fed hikes its discount rate, it does so slowly. Since it began the process at the end of 2016, it has raised the rate by 25 basis points, or a quarter of a percent, each time. The current rate is at 2 percent, which is still very low on a historical basis.
The stock market reacted badly to the possibility that the rate might rise 1 percent this year instead of 0.75 percent because even slightly higher borrowing costs can make a company less profitable.
But the discount rate also directly affects consumers, since it is used to set a bank's prime rate and is the basis for variable rate consumer credit, including credit cards.
The average credit card rate is already at or near record highs, so consumers carrying a large balance could see their interest charges rise, albeit slightly, later this year.