The prospect of the Federal Reserve not digging so deep into its bottomless pockets is beginning to affect investors.
The S&P 500 fell 2% on Tuesday – the worst one-day drop for the benchmark US index since May – as investors faced the expected reduction in the huge bond purchases the central bank has made since the start of the pandemic.
“The selloff highlights the extent of market nerves surrounding the Fed’s moves,” said Fiona Cincotta, senior financial markets analyst at Forex.com.
The upcoming slowdown in bond buying is a sign of the Fed’s confidence that the economy is recovering from the pandemic turmoil. But, Ms. Cincotta noted, other factors still make Wall Street wary.
“There is also a combination of rising energy prices, fears that inflation is no longer entrenched at these high levels and consumer confidence slowing,” she said.
The slide extended into the Asian trading day on Wednesday, although investors signaled that confidence could return.
Shares in Japan were down more than 2.6% by midday. But losses in other Asian markets, such as Hong Kong and mainland China, were more muted. Futures markets were signaling that Wall Street would open slightly higher.
The trigger for Tuesday’s slide, which affected all sectors, was a rise in the yield of the benchmark 10-year Treasury note. With the Fed preparing to slow down its purchases in November, investors sold bonds before demand ebbed. On Tuesday, that pushed the 10-year yield to 1.54%, its highest level since June.
Even though the Fed has said it doesn’t plan to raise interest rates for months or years, government bond yields are the basis for borrowing costs across the economy. . When bond prices fall, yields rise – a move that can hurt stock market performance as it makes holding bonds more attractive and may discourage riskier investments.
Tech stocks, particularly sensitive to the prospect of higher interest rates, were hit hard on Tuesday. The tech-heavy Nasdaq composite fell 2.8%, its biggest drop since February.
Higher rates would make borrowing more expensive for small businesses, and rising yields have dealt a blow to stocks in several high-flying stocks. Etsy, the online crafts marketplace, fell 6% and Shopify more than 5%. Both companies have soared during the pandemic.
“With tech stocks, you’re betting a company will make a breakthrough years from now,” said Beth Ann Bovino, chief U.S. economist at S&P Global. “If interest rates go up today, that value you receive years from now is discounted.”
The biggest technology stocks, including Amazon, Apple, Microsoft, Google and Facebook, have a extensive traction in the wider market and helped drag the S&P 500 lower. Apple fell 2.4% and was the best performing tech giant. Amazon fell 2.6% while Microsoft, Facebook and Google fell more than 3.5%.
But the declines affect many sectors. Energy stocks were the exception, rallying after rising oil prices earlier in the day. Schlumberger, ConocoPhillips, Halliburton and Exxon Mobil were among the best performing stocks in the S&P 500, although some of their gains faded as oil futures fell in the afternoon.
The Delta variant of the virus remains a concern for investors, while persistent supply chain bottlenecks have affected everything from automatic production for school meals. In Washington, lawmakers remain deeply divided on infrastructure spending and the expansion of social programs.
And another pressing fight is brewing over raising the country’s debt ceiling – a dispute that could trigger a government shutdown. Treasury Secretary Janet L. Yellen on Tuesday warned lawmakers of “catastrophic” consequences if Congress does not address the debt limit by Oct. 18.
The unease is apparent in the performance of stocks over the past four weeks. The S&P 500 is approaching a 4% decline for September, ending seven straight months of gains. The winning streak had sent shares soaring more than 20%, with investors largely appearing to ignore any bad news.
The bumpy times have usually involved the Fed. Tuesday’s trading echoed the volatility of the start of the year, when a jump in rates rocked financial markets. The rise came as traders feared higher inflation could push the Fed to raise rates sooner than expected.
“There’s no question the stock market doesn’t like higher rates — there’s just no debate about it,” said Ralph Axel, director of US rates strategy at Bank of America. .
Lauren Goodwin, an economist at New York Life Investments, wrote in a note to clients that investors have started looking for safer investments while weighing concerns including the fight against the debt ceiling and regulatory measures in China.
The Chinese government has shown signs of radically changing the policies that have guided its economy for much of the past decade, tightening regulations on topics including online gambling and data sharing by tech companies. And Beijing has so far been reluctant to bail out the faltering Evergrande Group, a beleaguered residential developer with $300 billion in debt, another change from usual policy.
But, Ms Goodwin wrote, risks like that “should not impact the broader fundamental environment”. Instead, she said, the forces driving the market in the near future would remain those that have done so over the past 18 months: the spread of the virus, government spending and Federal Reserve decisions. .
“The path will depend heavily on our three highly uncertain drivers – the pandemic, monetary policy and fiscal policy,” she wrote.
While the slowdown in bond buying will begin sooner rather than later, the Fed’s key interest rate – its most powerful and traditional tool – remains close to zero. And Fed Chairman Jerome H. Powell and his colleagues have signaled that the central bank is far from raising interest rates because it wants to see the labor market return to full strength before it does.
“The test for raising interest rates is significantly higher,” Powell said during a Senate Banking Committee hearing on Tuesday. What the Fed wants to see, he said, is a “really strong” labor market: “The kind of thing we saw before the pandemic hit.”
Jeanna Smialek and Matt Phillips contributed report.