Yesyesterday was a bad day for stocks, especially tech stocks.
The Nasdaq fell more than 2.8% at the close of the market, on what was its worst day since March, while the other two indices were not far behind, with the S&P down 2% and the Dow down 1.6%. As part of the rotation away from technology and growth, Treasury yields have skyrocketed. The yield on the 10-year benchmark bond rose 5 basis points to 1.54%, its highest level since June.
For investors, a one-day market drop is a potential sign of what’s to come, assuming worst-case scenarios. That is, a series of monetary and fiscal factors seem to be factored into stock exits and investor calculations. The evolution of these factors will determine the direction of actions in the short and medium term.
First, investors are still digesting last week’s FOMC meeting, in which Fed governors confirmed their intention to unwind the massive central bank balance sheet, while also hinting at a possible rate hike in 2022. After nearly two years of accommodation triggered by the pandemic, the Fed is showing signs of hawkishness, which may frighten some investors.
“Today’s interest rate-induced sell-off is reminiscent of the impact of monetary stimulus, with the Fed signaling a swift removal of upcoming emergency stimulus,” said Charlie Ripley, senior investment strategist for Allianz Investment Management. “This is an uncomfortable time for market participants as the removal of Fed support will soon be underway and the stock markets will have to relearn how to fend for themselves. However, it’s worth remembering that the Fed is unlikely to go ahead with cutting bond purchases if it doesn’t believe the economy is ready.
In other words, if the Federal Reserve starts lowering and raising interest rates before the economy is ready, havoc could ensue in equity markets; the threat of the Delta variant is particularly relevant here. Policymakers need to find the right timing.
Second, there is renewed concern about inflation as the supply-demand imbalance triggered by Covid continues to hamper supply chains and overall economic growth. High energy and commodity prices contribute to the inflationary environment; and President Powell focused on inflation in his remarks yesterday to the Senate Committee on Banking, Housing and Urban Affairs. “Inflation is high and will likely remain so in the months to come before it moderates,” he said.
Indeed, concerns about rising prices helped rock stock markets yesterday, some experts said. “The heightened inflation expectations due to the significant rise in energy prices caused long-term interest rates to soar in a short period of time,” said Brian Price, head of investment management for Commonwealth. Financial Network. “If interest rates rise moderately from here due to falling inflation expectations, it wouldn’t surprise me to see the market pick up its pace again as we move into the fourth quarter.” Namely, if inflation declines in the coming months as expected, this will play a key role in directing the 10-year yield and shaping Federal Reserve policy.
Third, there is the recurring drama of another debt ceiling deadline. While U.S. senators have always been successful in avoiding plunging the economy into this self-imposed financial cliff in previous years, the mere possibility that something is wrong on this occasion could frighten some investors.
“This is a sign of the dysfunctional times that Republicans will not go with Democrats by passing a debt ceiling increase, which has been done several times in the past in a bipartisan fashion,” said Chris Zaccarelli, director of investments. Officer of the Alliance of Independent Advisers. “Unfortunately, the financial system is somewhat held hostage by this week’s debt ceiling negotiations.”
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.