Everything is falling apart as investors adjust to the reality of the Fed

Bloomberg – There is nowhere to hide this week from the decline in financial markets.

Five large exchange-traded funds that trade stocks, bonds or commodities are about to record their first week of losses side by side in a month. Each has fallen by at least 0.8% in four sessions, and their simultaneous decline puts them at the third-worst level since October.

The broad declines accelerated after the Federal Reserve confirmed on Wednesday that it believes borrowing costs will remain high next year. Due to the strength of the American economy. In forecasts, 12 out of 19 officials said they expect another rise in interest rates this year and expect fewer cuts than previously expected, partly due to a stronger labor market.

“Many investors were waiting for the Fed to align with market expectations — they thought the Fed would adjust its thinking to be more in line with markets,” said Chris Gaffney, head of global markets at EverBank. “Instead, the Fed is standing firm, and now the market has to adjust to the Fed.”

The Standard & Poor’s 500 index fell on Thursday for the third day in a row, down 2% in that period. The Nasdaq 100 did even worse, losing 3%. According to HSBC Holdings plc, if the Fed sticks to its message of raising interest rates for longer, real yields could rise, triggering a broader sell-off.

The central bank is more aggressive than the market, and under a scenario of higher interest rates for a longer period, real yields could rise again. Max Ketner and Duncan Thoms, strategists at HSBC, believe that this scenario would be “worrying” and could lead to a general sell-off similar to the one that occurred in 2022. They both cite data from the past two years showing that rising real yields tend to hurt both equities and sovereign debt.

Only the dollar – and perhaps commodities – may be attractive in a multi-asset allocation in such a low-risk situation.

“This will constitute a ‘cyclical’ environment, one that is not unequivocally positive for stocks or carry asset classes, but one in which the dollar is performing very well, and cyclical asset classes such as financiers in stocks or energy are also doing well,” they wrote in a note. “Looking out to 2024, we still believe this is the most likely outcome.”

But instead of seeing Goldilocks forever – like the ones we saw in 2019 and 2021 -, there may be some bumps in the road. This time because turning points for inflation “really matter,” Kittner said, adding that a small decline in consumer prices a decade ago may have gone no more noticed than a drop to 3% from the bottom today, or 4.5%.

After the Fed’s aggressive pause, 10-year US Treasury yields have once again risen above global equity yields, Albert Edwards of Société Générale said in a note, adding that yields are at their highest levels in several decades. The strategist compared the current scenario with the scenario of 2007, “before everything collapsed.”

“How much pain from rising bond yields can stocks take now? Probably nothing.” Remember the Fed Model? He added, referring to the theory that stocks need to offer higher returns to remain competitive.

The decline in both bonds and stocks is particularly painful for a popular strategy that allocates 60% of funds to stocks and 40% to bonds. The 60/40 model index is down about 2% so far in September. With the 60-day correlation between the S&P 500 and benchmark Treasury securities reaching its highest level since February, The growing parallel movements call into question the role of fixed income as a hedge when riskier assets decline.

Meanwhile, billions of dollars have flowed into technology funds over the past year, with the sector seeing about $40 billion in cumulative global inflows, according to EPFR and Haver data compiled by Deutsche Bank through September 13. Money also went to the consumer goods sector, as well as the telecommunications and industrial sectors. But the current backdrop may not bode well for investors who have been betting on technology but are underweight in energy, a sector that has seen a rally in recent weeks, according to Bob Elliott, CEO and CIO of Unlimited Funds.

“High tech valuations, rising long-term yields and rising oil prices are putting this situation under pressure,” Elliott tweeted on Thursday.

— In collaboration with Kati Greifeld, Isabel Lee, and Denitsa Tsikova.