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U.S. stocks declined on Friday to close out a painful week for markets, as the Federal Reserve’s hawkish signals on interest rates weighed heavily on sentiment.
The Dow Jones Industrial Average fell 106 points, or 0.3%, finishing near 33,964. The S&P 500 dipped 0.2% to settle around 4,320, while the tech-heavy Nasdaq Composite edged down 0.09% to end around 13,212.
The losses on Friday capped a four-day slide for the major indexes, culminating in the worst week for the S&P 500 and Nasdaq since March. The S&P 500 plunged 2.9% this week, while the Nasdaq sank 3.6% over the same stretch. The blue-chip Dow shed 1.9% this week for its first weekly setback since July.
The intense selling pressure came in response to the Fed indicating rates could remain elevated through 2023, dashing hopes for any imminent policy pivot. Surging bond yields and recession worries also plagued stocks as markets reposition for a higher-for-longer environment aimed at taming high inflation.
“Investors are staring at the ground right now worried about a shutdown,” said Jamie Cox of Harris Financial Group. “Markets are just sort of waiting around to see when it happens, and then trying to discount the duration of it.”
Fed Signals Rates to Stay High, Rattling Markets
The steep stock selloff really gained momentum on Wednesday following the Fed’s latest policy directive, which included another 75 basis point rate hike as anticipated.
However, updated projections revealed a more aggressive path for rates than previously forecast. The so-called dot plot now shows rates reaching 4.4% by year-end, up noticeably from the 3.4% level seen in June.
The fed funds benchmark is also expected to top out above 5% in 2023 before starting to decline in 2024. But even by then, rates are seen remaining above the Fed’s 2% inflation target.
This shift toward higher rates for longer aims to restrain an economy seemingly strong enough in the Fed’s view to tolerate the policy pain required to conquer high inflation.
An unexpected drop in weekly jobless claims further solidified the Fed’s thinking that the labor market remains too tight. The low 194,000 claims reinforce upward wage pressures that filter through to overall inflation.
But the prospect of higher rates persisting into 2024 has markets questioning whether the Fed can tame inflation without triggering a recession. Analysts caution the lagged impacts of tighter policy have yet to fully take hold.
“We’re starting to raise some eyebrows for investors,” said Charlie Ripley of Allianz. “Investors are getting used to these higher rate levels and what that means for risk assets going forward.”
Surging Yields Add to Pressure on Stocks
Alongside the Fed’s hawkish shift, Treasury yields spiked to their highest levels in 15 years, further weighing on sentiment.
The closely-watched 10-year yield reached 3.71%, its loftiest mark since 2010. The 2-year yield also jumped to a 15-year peak above 4% as traders priced in more Fed tightening.
Rising long-term rates pressure equity valuations and increase borrowing costs for consumers and businesses across mortgages, auto loans, credit cards, and corporate bonds.
Rate-sensitive sectors like real estate and technology took the brunt of the selling pressure. Real estate fell over 3% on Friday for its biggest decline since March 2020.
Meanwhile, recession warnings flashed as parts of the yield curve remained deeply inverted. When shorter-term yields exceed longer-term yields, it historically signals a downturn within 12 to 18 months.
Supply hurdles, geopolitical turmoil, dollar strength, and other risks cloud the economic picture further. Fears of a government shutdown heightened after the House went on recess amid budget debates.
All 11 S&P 500 sectors finished lower on Friday, with technology down over 1% and communication services sinking 1.7%.
Among individual stocks, Ford rose 1.9% following reports of progress in UAW labor talks. Oil gained over 3% on tight supply, with JPMorgan eyeing $150 crude in a bullish scenario.
Even with recent declines, long-term investors should maintain focus on quality and portfolio resilience while awaiting clarity on policy and markets.
Global Central Banks Reaffirm Tightening Stance
The Fed’s latest posturing reinforced a globally coordinated effort by central banks this past week to reiterate their commitment to tighter policies even at the risk of slowing growth.
With inflation still running well above targets, policymakers are prioritizing price stability through interest rate hikes and balance sheet reduction despite emerging economic weakness abroad.
The Bank of England, Swiss National Bank, Norway’s Norges Bank, and others joined the Fed in telegraphing a firm hawkish stance. The resolve comes as growth forecasts dim.
“From a central bank cycle point of view, duration is attractive as rate hiking cycles are coming to a quick end,” said Citi’s Dirk Willer. “However, central banks have not been given the all clear yet.”
In particular, the European Central Bank is balancing inflation near 10% against faltering growth and an energy crisis tied to Russia’s war in Ukraine.
According to Citi, the Fed and ECB are getting close to completing their tightening campaigns as policy nears “sufficiently restrictive” levels. But any hints of easing are unlikely until clear disinflation materializes.
Markets on Shaky Ground Heading Into Quarter-End
Major stock indexes remain solidly lower in September, typically the worst calendar month for equities. Investors now look to finish out the quarter on a weak note.
Recession odds for 2023 have climbed above 50% given aggressive central bank tightening amid economic and geopolitical headwinds. Still, resilient job markets have yet to crack in a way that would warrant a Fed policy pivot.
“It is not the time to buy this cover bid rally,” advised Goldman’s Scott Rubner, warning against fading Friday’s late comeback attempt. “We are in the middle of the worst seasonal equity period of the year right now for the market to close out Q3.”
With risks skewed to the downside, defensive positioning and high-quality stocks may offer stability as uncertainty persists. U.S. midterm elections, corporate earnings, and inflation data will also steer sentiment in the period ahead.
Navigating the Fed-driven volatility requires assessing portfolio resilience and long-term time horizons. Maintain balanced exposure across stocks, bonds, commodities, and alternatives.
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Fed Uncertainty Puts Market on Defensive Heading Into October
After a brutal September, the fourth quarter kicks off with the Fed, inflation, and recession risks still dictating market direction.
The path of monetary policy remains the critical wildcard swaying sentiment and positioning. The Fed’s latest shift to prioritizing inflation-fighting over growth has investors reassessing recession odds and earnings trajectories.
According to DataTrek Research, the market is currently anticipating an 81% chance of a recession next year based on trading in fed funds futures contracts. Major banks have also raised recession odds, with Deutsche Bank forecasting a downturn early next year.
While job markets and consumer spending have proven resilient so far, analysts expect the full brunt of cumulative Fed tightening is yet to be felt across the economy.
“We’re starting to raise some eyebrows for investors,” said Allianz’s Charlie Ripley. “Investors are getting used to these higher rate levels and what that means for risk assets going forward.”
This leaves earnings estimates vulnerable to downgrades if higher rates and a slowing economy hit corporate profits harder than expected. Inflation ate into margins across many sectors in the first half of 2022.
At the same time, technical indicators reflect extremely oversold conditions that could foreshadow a corrective bounce. The S&P 500’s 14-day Relative Strength Index recently fell below 30 for just the third time since 2020.
While bears have the upper hand, bulls will look for signs of a Fed pivot to regain control of the tape. Any indications of the central bank easing up on its monetary policy tightening plans could quickly shift momentum.
Navigating Fed Uncertainty With Defensive Positioning
For investors seeking shelter from the storm, shifting toward defensive sectors and stocks with durable income streams offers one approach aligned with the risks.
“We’ve seen investors migrate to more defensive positioning,” said Yung-Yu Ma of BMO Wealth Management. “The prospects of a recession serve as motivation to get more defensive.”
Areas like healthcare, utilities, and consumer staples tend to hold up better during times of economic uncertainty relative to cyclical sectors.
At the stock level, focusing on companies with strong pricing power, low debt, and consistent profitability can also aid in resilience. Dominant franchises with loyal customer bases often shine during downturns.
Moderating return expectations and building in valuation cushions also seem prudent given the headwinds. With all the crosscurrents, sticking to disciplined rebalancing that avoids drastic shifts serves