Wall Street gets it. After months of hints from the Federal Reserve that it means business about raising rates, traders have finally stopped fighting the Fed. The result: a flattening yield curve, and an equity sell-off right into the close. Why? The market fears overtightening.

Jerome Powell’s impact

Just yesterday, new Federal Reserve Chairman Jerome Powell effectively told Congress that he believes in a rules-based approach to policy that would effectively double the Fed’s target rate. At the same time, he made clear that the rate hikes likely won’t stop in 2018. And he talked up inflation and economic overheating as the main worries for monetary policy.

Markets didn’t like any of this, closing today considerably lower for the second day running. What’s more, even as the 1-year Treasury yield increased in response to Chairman Powell’s remarks, long-term interest rates sank, flattening the yield curve. Curve flattening is where the differential between short-term interest rates and long-term ones diminishes. And it is a sign of perceived monetary tightening.

Weaker economic figures

The problem is that revised numbers show the US economy growing only 2.5% in the quarter ending in December. That’s lower than the first estimate. It’s also lower than the 3 to 4% growth US President Donald Trump is arguing for. And it is close enough to the 2%ish growth that some have labelled secular stagnation. Moreover, the Atlanta Fed GDPNow tracker just lowered its estimate for this quarter’s growth to 2.6%, down from 3.2% on February 16th. That’s considerably less than the 5.4% I mentioned at the beginning of the month. But the Fed Chairman just told us yesterday that he is more optimistic about the US economy now than two months ago. And he sees tightening policy as necessary to prevent inflation.

So we have a situation where the Fed is more hawkish and the economy is less robust. The Fed as the monopoly supply of reserves can and will push the market until it cries uncle. Powell’s testimony before Congress is the Fed Chairman’s first warning shot. Caveat emptor.