The Federal Reserve today fulfilled investor expectations by announcing a modest hike in interest rates. Stocks sharply rose on the news. But then came the press conference.

After Fed Chair Jerome Powell finished his late afternoon press conference, investors interpreted his remarks as too hawkish. In the final half hour of trading, stocks reversed direction and went south. The major indices closed deeply in the red. During the session, the Dow registered a swing of about 200 points.

The Fed announced at the end of its two-day meeting Wednesday that it would raise its fed funds rate (its benchmark overnight lending rate) by a quarter of a percentage point, to a range of 2%-2.25%. It marked the Fed’s third hike this year; the central bank indicated it plans to raise rates again in December.

Powell reaffirmed the Fed’s faith in the resilience of the recovery but also indicated that over the long haul, the Fed would adopt a less accommodative stance. He warned that if the Fed didn’t act decisively, the economy would overheat. It belatedly sunk in with investors that the punch bowl is gone and the party is over.

The economy is indeed robust. The Commerce Department reported today that year-to-date home sales are 6.9% higher than the same period last year. According to the department’s data released last month, U.S. gross domestic product (GDP) grew at a 4.2% annualized rate in the second quarter.

The unemployment rate currently stands at 3.9%, a level the Fed considers close to “full employment.” Average hourly earnings are growing and consumer confidence hit an 18-year high this month.

However, into this happy mix comes the double-edged sword of massive tax cuts — $1.5 trillion worth. The recovery is nearly nine years old. Stimulus at this late stage in the economic cycle could be too much of a good thing.

The Fed tries to strike a balance between the twin dangers of recession and inflation. The margin for error is shrinking.

It took a decade of ultra-low rates to get economies back on their feet. The magnitude of this stimulus is unprecedented. The seeds of inflation are sown. If the Fed sees fit to raise rates more than expected in the coming months, it could trigger a market crash.

We’ll get another indication of future Fed policy on Friday, when the government releases its core inflation data.

The new world disorder…

Powell stated today that tariffs have yet to harm the U.S. economy. The facts indicate otherwise.

The American Farm Belt is feeling the acute pain of agricultural tariffs, while auto makers and other industrial firms are struggling with steel tariffs. Scores of manufacturers are reporting higher input costs because of levies, which they plan to pass along to consumers.

Meanwhile, the trade war dampened China’s GDP growth in the second quarter:

Source: Trading Economics

The Chinese stock market is down about 25% from its peak in January. China is the world’s growth engine. When the Middle Kingdom sneezes, the globe catches the flu. 

Powell said today that tariffs would start to take a serious toll, but only if they’re left in place for a lengthy period of time. Here’s a fact that many analysts are too myopic to see: once implemented, tariffs are difficult to reverse. History shows that they usually stay in place for years, as businesses change their operations to adapt.

China’s mercantilist policies undoubtedly abuse the trade rules. America is right to demand more fairness from China. However, most economists agree that tariffs only make matters worse.

Steadfast but rational negotiation remains the most effective route for redressing trade disputes. Instead, the post-World War II system of multilateral cooperation is crumbling.

President Donald Trump yesterday gave a speech to the U.N. General Assembly that was fiercely “America First” in tone. The president touted his tariffs on $250 billion in Chinese-made goods. Problem is, America First puts investors second.

Trump’s latest round of tariffs is set to automatically rise from 10% to 25% on January 1. This week, Walmart (NYSE: WMT) and Target (NYSE: TGT) warned that tariffs would result in higher prices for their shoppers.

Major retailers expect tariffs to hurt their bottom lines. Several export-dependent manufacturers are bracing for earnings haircuts.

Another concern is Brexit, the term for Britain’s planned exit from the European Union. As the Brits would say, negotiations are “a cock-up.” Major issues remain unresolved, ahead of the March 2019 deadline for an agreement between London and Brussels.

Britain’s Prime Minister Theresa May insisted yesterday that she wasn’t bluffing when she said that no deal was better than a bad deal.

A “hard” Brexit would spook financial markets, clobber Britain’s growth, and disrupt the EU’s $19.7 trillion-a-year economy. The London Stock Exchange estimates that Brexit will cause Britain to lose 232,000 jobs.

Complacent equity investors aren’t preparing for this new world disorder. Expect more curveballs ahead.

Wednesday Market Wrap

• DJIA: 26,385.28 -106.93 (0.40%)
  
• S&P 500: 2,905.97 -9.59 (0.33%)
  
• Nasdaq: 7,990.37 -17.10 (0.21)%
  

Wednesday’s Big Gainers

• XOMA (NSDQ: XOMA) +14.23%

Biotech buys rights to drug royalties from peer.

• Canada Goose Holdings (NYSE: GOOS) +10.36%

Major analysts give coat retailer a buy rating.

• Vanda Pharmaceuticals (NSDQ: VNDA) +8.72%

Biotech set to join S&P SmallCap 600 index.

Wednesday’s Big Decliners

• Entasis Therapeutics (NSDQ: ETTX) -28.93%

Wall Street looks askance at biotech’s IPO.

• Aceto (NSDQ: ACET) -15.55%

Generic drug distributor dropped from S&P SmallCap 600 index.

• Chegg (NYSE: CHGG) -12.09%

Online learning platform discloses data breach.

Letters to the Editor

“Can you quantify the potential damage of a trade war?” — Martin D.

Investment bank UBS Group (NYSE: UBS) calculates that a full-scale trade war between the U.S. and China, encompassing all threatened tariffs, would slash profits for S&P 500 firms by 14.6%, with U.S. and global growth being 245 and 108.5 basis points lower, respectively.

Opinions about the trade war? Get them off your chest: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily.