Rising interest rates rocked the stock market as hot inflation tests the Fed

Jerome Powell, Chairman of the U.S. Federal Reserve, speaks during a House Finance Committee hearing in Washington, DC on Wednesday, December 1, 2021.

Al Drago | Bloomberg | Getty Images

U.S. stocks resumed their selloff on Monday as government bond yields continued to climb, a hint that many traders are increasingly certain the Federal Reserve is poised to raise interest rates over the next few months.

Traders say the pressure on US stocks is not due to material concerns about the economy or fears of a massive Covid-19 resurgence, but the repositioning of the portfolio for a world with borrowing costs higher.

As the country’s central bank, the Fed is tasked by Congress with maximizing employment and keeping prices stable. The Fed is adjusting short-term interest rates and other liquidity tools to keep inflation around 2% and reduce unemployment as much as possible.

When the Fed determines that the economy is close to full employment – and especially if inflation is high – it raises interest rates to make it harder for businesses to borrow and to limit the spending that drives up prices. .

The Labor Department reported in December that the prices consumers pay for goods and services rose more than 6% in November and registered their biggest year-over-year jump since 1982.

Many market watchers, including Charles Schwab’s Randy Frederick, say impressions of hot inflation almost guarantee Fed rate hikes in the months to come. Members of the central bank have already telegraphed that they plan to restrict access to cash faster than expected.

Those expectations have pushed the benchmark 10-year Treasury yield higher in recent weeks, with the rate last rising around 1.77% from a low below 1.4% in December. Fluctuations in the 10-year yield can potentially have a direct impact on consumers through higher mortgage rates and auto loans.

Frederick, director of trading and derivatives at the Schwab Center for Financial Research, explained that the market seemed to be caught off guard by President Jerome Powell’s fulcrum, who was moving away from labeling inflation as “transient” and was moving towards a more restrictive monetary policy.

“These are both efforts to tackle rising inflation, which I think has gone much further and much faster than [Powell] had planned, ”he said. “So now you have the potential for interest rates, which seemed not to start rising until June. Now, there is about an 80% chance that this will happen in March. “

Frédéric is not the only one to think so. The latest minutes from the Fed meeting, coupled with high inflation and near full employment, led Goldman Sachs to tell clients it now expects four rate hikes in 2022, more than foreseen.

Markets now believe there is a 76% chance the Fed will hike interest rates at the Federal Open Market Committee’s March meeting, down from around 15% in mid-October, according to the group’s FedWatch site. CME.

Monday’s sale also comes a day before Powell appears before Congress for his nomination hearing. Lael Brainard, whom President Joe Biden has named as the next central bank vice president, will testify on Thursday.

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Lawmakers, troubled by rising prices at the gas pump and in grocery stores, should explain to Powell how he and his Fed colleagues plan to bring inflation back to the Fed’s 2% target.

But higher rates – or the market’s expectations for higher rates – can cause financial heartburn, as traders sell high-priced treasury bills and stocks.

“In the tech industry, which tends to trade at a very high valuation, there are a lot of new companies that have debt and leverage,” Frederick said. These companies may have a harder time keeping cash on hand “because when that debt expires, it will have to be replaced at a higher rate.”

Among the three major US stock indexes, recent traders’ sales have focused on the stocks that make up the technology-heavy Nasdaq Composite. The Nasdaq is 8.5% below its all-time high, against a 3.5% drop for the S&P 500 and a 2.7% drop for the Dow. The Russell 2000, an index that tracks small public companies, is more than 12% below its all-time high.

Sectors and stocks viewed as more defensive financially, with better near-term earnings expectations, outperformed. Utilities like Xcel Energy and Duke Energy advanced while drugmakers Merck and Amgen rose 2% and 1% respectively.

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