Stocks plagued by Fed rate jitter as yields rise: Markets plummet

(Bloomberg) – A rebound in Treasury yields spurred a fall in stock prices, with geopolitical tensions and gloomy forecasts from leading companies Walmart Inc. and Home Depot Inc. also weighing on investor sentiment.

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Wall Street’s growing fears that the Federal Reserve is nowhere near completing its fight against inflation — let alone turning it around — fueled bond investors who had been betting on rate cuts at one point this year. As traders increased their bets on the Fed, US yields hit new highs for 2023. And the latest to join the so-called “everything rally” – stocks – are now showing signs of losing momentum.

In a sell-off that gripped all major groups in the S&P 500, the benchmark erased its monthly gain and headed for its worst fall since mid-December. Tech stocks led losses Tuesday, with the Nasdaq 100 down about 2%. The Cboe volatility index, which had been stubbornly low earlier this year, rose for a second day, topping 23. The dollar halted its two-day slide.

While recent economic data suggests the US may be dodging a recession, a hawkish Fed and increased earnings forecasts make the risk/reward trade-off for equities look “very poor,” according to Morgan Stanley’s Michael Wilson. This obviously bodes ill for the market after a strong rally that has left equities at their most expensive levels since 2007 as measured by the equity risk premium.

“It’s gotten to a point where stock markets feel a little overpriced given where we are right now,” Liz Young, SoFi’s head of investment strategy, told Bloomberg Television. “The Fed has more to do, and we all know the long and variable delays it takes for monetary policy changes to make their way through the economy. It’s hard for me to look at that in this environment and say, ‘Yeah, we should be paying 18x expected earnings.’”

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Others on Wall Street have also warned that stocks’ recovery may have gone too far.

JPMorgan Chase & Co.’s Mislav Matejka said bets on robust economic growth and a Fed pivot are premature, while Bank of America Corp. strategist Michael Hartnett sees the S&P 500 falling to 3,800 points by March 8, which means a drop of about 7% its last closure. Far more dovish, Wilson thinks the index could fall as low as 3,000 points in the first half of 2023 — a 26% drop from Friday.

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Swaps remained adamant that the Fed will continue to hike rates, with the market indicating that hikes of 25 basis points are imminent at the March, May and June meetings. Investors are pricing in an increase in the federal funds rate to around 5.3% in June. This compares to a perceived high of 4.9% just three weeks ago.

“If interest rates stay around 5% longer, valuations with extremely modest risk premiums are likely to be very vulnerable to market shocks,” said Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management. “Investors should note that a Fed that stays higher longer term is likely to raise not only the terminal rate but also the longer-term neutral rate – which will create headwinds for long-duration valuations.”

Cantor Fitzgerald’s Eric Johnston said he remains bearish on stocks – and his conviction remains high. Johnston says he can no longer disagree with the view that the US will not see a recession and will instead see a soft landing or no landing at all. The economy’s performance is not an indication of what it will be like in six to 12 months, he noted.

While the stock market has staged an impressive recovery so far this year, markets are still trying to adjust to the reality that the Fed is unlikely to pivot and instead is still focused on fighting inflation, suggesting that investors be prepared for interest rates to remain high for longer, said Carol Schleif, chief investment officer at BMO Family Office. That means “we could see sustained volatility into year-end.”

Schleif also notes that Wednesday’s Fed minutes will be particularly relevant given the recently released inflation and employment numbers, which are still high and illustrate a hot economy. The Fed’s preferred indicator of inflation later this week – coupled with a baseline pick-up in consumer spending – will fuel debate among central bankers about the need to adjust the pace of rate hikes.

For Jan Hatzius of Goldman Sachs Group Inc., traders should expect the central bank to hike interest rates by a quarter of a point at its March, May and June meetings in response to stronger economic expansion.

If history is any guide, the stock market has yet to bottom. The S&P 500 bottomed only after the Fed stopped raising rates in previous hike cycles, implying more downside if the trend continues, according to data compiled by Bloomberg. US stocks surged 17% from a low in October to a high in early February before gains eased.

JPMorgan Chase & Co.’s latest client survey shows that stock positioning is still trending toward the declining percentile, with just 33% of respondents saying they’re likely to increase exposure in the coming weeks. In the meantime, the futures positioning of asset managers and leveraged funds has turned positive again.

Investors have also been keeping a close eye on recent geopolitical developments.

President Vladimir Putin said Russia would suspend its observance of the New START nuclear weapons treaty with the US, a decision Foreign Minister Antony Blinken called “irresponsible”. Meanwhile, the White House will not be afraid to sanction Chinese companies that support Russia’s invasion of Ukraine, Deputy Treasury Secretary Wally Adeyemo said.

Read: China Tech Giants Plunge Amid Growing Fears of Price War

Elsewhere, Credit Suisse Group AG hit a record low on a report that its chairman is facing an investigation for saying the company has halted huge customer outflows after a series of share falls.

Important events this week:

• US MBA Mortgage Applications, Wednesday

• The US Federal Reserve published the minutes of its last policy meeting on Wednesday

• Eurozone CPI, Thursday

• US GDP, Initial Jobless Claims, Thursday

• Atlanta Fed President Raphael Bostic speaks Thursday

• BOJ governor-nominee Kazuo Ueda appears before Japan’s lower house on Friday

• US PCE Deflator, Personal Expenditure, New Home Sales, University of Michigan Consumer Sentiment, Friday

• Russia’s invasion of Ukraine hits the one-year mark on Friday

Some of the key movements in the markets:

Shares

• The S&P 500 was down 1.7% as of 12:31 p.m. New York time

• The Nasdaq 100 fell 2%

• The Dow Jones Industrial Average fell 1.7%

• The MSCI World Index fell 1.4%

currencies

• The Bloomberg Dollar Spot Index rose 0.2%

• The euro fell 0.3% to $1.0658

• The British pound rose 0.6% to $1.2112

• The Japanese yen fell 0.4% to 134.84 per dollar

cryptocurrencies

• Bitcoin fell 1.4% to $24,422.8

• Ether fell 2.1% to $1,665.74

Bind

• The 10-year government bond yield rose 10 basis points to 3.91%

• The 10-year German government bond yield rose seven basis points to 2.53%

• The 10-year UK government bond yield rose 14 basis points to 3.61%

raw materials

• West Texas Intermediate Crude fell 0.1% to $76.25 a barrel

• Gold futures fell 0.4% to $1,843.60 an ounce

This story was created with the support of Bloomberg Automation.

–Assisted by Vildana Hajric, Peyton Forte, Isabelle Lee and Farah Elbahrawy.

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