Market Anxiety Drove Stocks Lower, Leading into Wednesday’s Fed Meeting

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Stocks fell as market anxiety over the Fed persisted. Prior to the meeting on Wednesday
Before the Federal Reserve’s interest-rate announcement on Wednesday, bond yields reached fresh highs on Tuesday, which caused the stock market to decline.

The S&P 500 plummeted 1.1%, the Nasdaq Composite sank 1%, and the Dow Jones Industrial Average dropped 313 points or 1%.

According to Edward Moya, senior market analyst at Oanda, “U.S. stocks are declining as Wall Street anticipates the Fed to stay aggressive in their fight against inflation.” Yields are increasing.

Treasury yields are rising due to the Fed’s widely anticipated Wednesday three-quarter point rate hike. The 2-year Treasury yield, which most accurately predicts the direction of monetary policy, increased to 3.962%, while the 10-year yield, which more accurately predicts inflation expectations over the longer run, increased to 3.571%. Both yields hit fresh multi-year highs at the closing.

Hotter-than-expected inflation has rekindled expectations that the Federal Reserve would continue to aggressively raise short-term interest rates, which has caused the most recent run-up in yields to occur in about the past month and a half. The CME FedWatch Tool predicts that the Fed will raise rates by three-quarters of a point on Wednesday, with a 20% possibility of raising rates by a full point. A three-quarter point increase hadn’t happened since 1994 until this year.

The S&P 500 entered Tuesday’s open down a little over 9% from the summer rally’s mid-August top, so that move is now clearly known. Therefore, if a three-quarter point increase is already represented in the stock market, it might spark a surge.

However, the market needs more than that for the rebound to be meaningful—or maintained. The crucial question is what the central bank says or hints about potential rate increases. Since higher rates are intended to dampen economic demand to prevent inflation, the stock market would like to see a slowing in the rate of rate increases.

According to Tom Essaye of Sevens Report, “Tomorrow’s FOMC decision will probably either further pressure equities… or provide markets some reassurance that the Fed isn’t going to hike rates as much as anticipated, and in doing so, allow markets to bounce.”

Not just the Fed is a central bank using extreme measures to control inflation. The Riksbank of Sweden increased short-term rates by a full percentage point on Tuesday, citing continued rising inflation. On Thursday, the Bank of England is anticipated to increase rates by 0.5 percentage points.

Another factor driving rising U.S. rates is that these events have led to higher short-term bond yields in Europe. When international yields increase, the higher-yielding U.S. market frequently sees rate increases. This is because when U.S. rates gradually lose some of their attractiveness, selling pressure on U.S. fixed-income assets increases, driving down their prices and raising their rates.

Dennis Debusschere of 22V Research states, “Sweden’s central bank chose to hike the repo rate by 100bps to 1.75% (markets were anticipating a 75bp rise), resulting in a strong surge in European bond rates that are also influencing UST yields.”

In the end, Fed Wednesday will be the primary factor influencing changes in U.S. rates and stocks. Right now, all we can do is wait.

Dow’s Ongoing Weakness

On Tuesday, the Dow fell 421.03 points, or 1.3%, to 30,598.65 as the Federal Reserve prepared to decide on an interest rate. On Wednesday, the Fed is expected to increase interest rates by at least 0.75 percentage points, but this is not the main concern for the stock market.

What the Fed will do in November is no longer the central concern; instead, the focus has shifted to what the fed-funds rate will be when increases ultimately come to a halt. The market is concerned about more than just rates rising significantly from initial predictions of just over 3%—possibly as high as 5%. The Fed may potentially maintain higher rates for a longer period than anticipated.

Higher rates first hurt corporations with high valuations because lower stock multiples result from higher “discount rates.” The costly growth stocks that make up most of the Nasdaq Composite have been harmed more than the more diversified holdings in the S&P 500SPX -1.13% and the Dow. However, as the Fed continues to tighten monetary policy, the market’s main fear is the risk of a recession, which damages economically sensitive equities, like those in the Dow, more than the businesses in the Nasdaq.

That may be what takes place on Tuesday. The Dow has dropped more than the Nasdaq, down 1.1%. The level it first passed to the upside in 2020 with much enthusiasm is now just 598.65, away from 30,000. These days, a 2% reduction is hardly a significant one. (Of course, barely dropping below 30,000 doesn’t qualify as a break. On June 17, the Dow reached a low of 29,888.78, but it ended up being the bottom.)

The most important thing is that these lows stay. The S&P 500 was two days away from its bottom of 3666.77 at the same time the Dow reached its low of 2022. And that’s where the major conflict ought to occur, says Ron Meisels of Phases & Cycles. On the one hand, a “double bottom” and some unexpected news might provide support for the S&P around 3670. According to him, that would trigger a year-end surge. However, if 3670 were to break, the next level of support would appear around 3500.

Meisels does not dial a number. We don’t often provide either-or projections, but at present, the possibility of further bad news from the FED makes that difficult, according to Mesiels.

https://www.barrons.com/articles/-dow-under-30k-51663702319?mod=livecoverage_web
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