Higher interest rates upset stock markets as hot inflation tests the Fed

U.S. stocks continued their sell-off on Monday as government bond yields continued to rise, a sign that many traders are increasingly certain that the Federal Reserve will raise interest rates over the next few months.

Traders say the pressure on US stocks is not due to worries about the economy or fears of a major Covid-19 resurgence, but rather to repositioning portfolios for a world of high costs. higher borrowing.

As the nation’s central bank, the Fed is tasked by Congress with maximizing employment and keeping prices stable. The Fed adjusts short-term interest rates and other liquidity tools to keep inflation around 2% and cut 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 companies to borrow and curbs spending that drives prices up.

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

Many market watchers, including Charles Schwab’s Randy Frederick, say hot inflation prints all but guarantees the Fed will raise interest rates in the coming months. Members of the central bank have announced that they plan to restrict access to cash faster than first predicted.

Those expectations have driven yields on 10-year Treasuries higher in recent weeks, with last seen rate to about 1.77% from a low of less than 1.4% in December. Movements in 10-year yields could eventually 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 markets appear to be caught off guard by Chairman Jerome Powell’s pivot away from calling inflation “transient” and towards more restrictive monetary policy.

“Those are both efforts to combat rising inflation, which I think has gone much further and faster than [Powell] “He was expecting”. So now that you have the potential for interest rates, it looks like they probably won’t rise until June. Now there is like 80% probability that will happen in March. “

Frederick is not alone in that thought. Minutes of the Fed’s latest meeting, coupled with hot inflation and near-filled jobs, prompted Goldman Sachs to tell clients it expected four rate hikes in 2022, more than previously expected. this.

Markets now see a 76% chance of the Fed raising rates at the Federal Open Market Committee’s March meeting, up from about 15% in mid-October, according to a report. CME Group’s FedWatch Website.

Monday’s sell-off also comes a day before Powell is due to appear before Congress to testify on his nomination. Lael Brainard, who has been nominated by President Joe Biden to be the next vice president of the central bank, will testify on Thursday.

Lawmakers, baffled by rising prices at gas stations and at grocery stores, are expected to speak to Powell about how he and his colleagues at the Fed plan to correct inflation again. Fed’s 2% target.

But a higher rate — or market expectations of a higher rate — can cause financial heartburn as traders sell overvalued Treasuries and stocks.

“In the tech sector, which tends to trade at very high valuations, there are a lot of new companies with debt and leverage,” says Frederick. Those companies may have a harder time keeping cash “because when that debt expires, it will have to be replaced at a higher rate.”

Among the three major US equity indexes, recent selling by traders has focused on stocks including Nasdaq Composite. Nasdaq is 8.5% below all-time high compared to 3.5% drop of S&P 500 and 2.7% off for Industrial Dow. Russell 2000, an index that tracks smaller public companies, was more than 12% below its record.

Sectors and stocks are considered to be more financially defensive, with expectations of better, better short-term returns. Utility companies like Xcel Energy and Duke Energy achieved while drug manufacturers Merck and Amgen increased 2% and 1% respectively.