US stocks and government bonds are enduring their most challenging month of the year as investors react to the Federal Reserve’s clear message that interest rates will remain higher for an extended period.
In September, Wall Street’s S&P 500 stock index has dropped by more than 5 percent, bringing it perilously close to its first quarterly loss in 12 months.
The decline in the US bond market has also accelerated following the Fed’s announcement that it intends to raise rates more gradually in 2024 and 2025 than previously anticipated. Last week, the yield on 10-year Treasuries reached its highest level since 2007, marking the largest monthly increase in a year.
Mark Dowding, Chief Investment Officer at RBC BlueBay Fixed Income, noted, “The penny [is] dropping that actually higher for longer means higher for longer.” This realization has dampened sentiment among investors.
At the start of the month, futures market traders projected an interest rate of approximately 4.2 percent by the end of 2024. Now, they are betting on rates of 4.8 percent by that time.
Kevin Gordon, Senior Investment Strategist at Charles Schwab, commented, “The market has been consistently wrong about Fed policy this year. For a good chunk of the year, the market expectation was it would be cutting aggressively this year… now there’s an embrace of ‘maybe [the Fed] actually means it’.”
The anticipation of an extended period of high rates has impacted equities, primarily due to the influence of higher bond yields on investors’ pursuit of returns and their potential effects on the real economy.
While the S&P is still up 11 percent for the year, it has been supported by a small number of technology stocks with significant weightings that surged earlier in the year. The equal-weighted version of the index recently slipped into negative territory for the year.
Corporate debt markets have also felt the impact, as concerns mount that highly leveraged companies may encounter challenges refinancing their debt in the face of higher rates.
The average interest rate for US junk bonds has risen from 8.5 percent to nearly 9 percent this month, surpassing the increase in Treasury yields.
This shift in the US comes as the Federal Reserve responds to strong economic data and a robust labor market, in stark contrast to the eurozone and the UK, where recession concerns loom large.
Sonal Desai, Chief Investment Officer at Franklin Templeton Fixed Income, stated, “It’s like the market is finally getting on board with the view that we’re not on the brink of a recession.”
Fed officials recently revised their unemployment forecasts upward and raised their growth projections. While the central bank kept its main interest rate steady at a range of 5.25 percent to 5.5 percent, its policymakers signaled one more rate hike this year.
Surging oil prices have exacerbated concerns about persistent inflation and tight monetary policy. Brent crude surged by nearly 3 percent to a 10-month high of over $97 a barrel, driven by lower-than-expected US stockpiles and fears of a global supply shortfall.
Some investors worry that higher rates, if sustained, could eventually push the economy into a recession despite strong recent economic data. Jeff Schulze, Head of Economic and Market Strategy at ClearBridge Investments, expressed concern about the potential lagged effects of Fed tightening, stating, “The longer rates are up there, the higher the chance.”
