Fears about a fragile economy and stubbornly high inflation have slammed the stock market in recent days and sent Treasury yields surging to their highest levels in years.
A report last week that inflation was getting worse, not better as many had hoped, sent a chill through markets that carried over into this week. Investors expect the Federal Reserve will get more aggressive to get inflation under control, even if it risks a recession.
Canada’s main stock index meanwhile moved into correction territory to start the trading week.
The S&P/TSX composite index had its second-worst day of the year by losing 532.26 points or 2.6 per cent to 19,742.56.
The centre of Wall Street’s focus was again on the Federal Reserve, which is scrambling to get inflation under control. Its main method is to raise interest rates in order to slow the economy, a blunt tool that risks a recession if used too aggressively.
Some traders are even speculating the Fed on Wednesday may raise its key short-term interest rate by three-quarters of a percentage point. That’s triple the usual amount and something the Fed hasn’t done since 1994. Traders now see a 30 per cent probability of such a mega-hike, up from just three per cent a week ago, according to CME Group.
No one thinks the Fed will stop there, with markets bracing for a continued series of bigger-than-usual hikes. Those would come on top of some already discouraging signals about the economy and corporate profits, including a record-low preliminary reading on consumer sentiment that was soured by high gasoline prices.
It’s all a whiplash turnaround from earlier in the pandemic, when central banks worldwide slashed rates to record lows and made other moves that propped up prices for stocks and other investments in hopes of juicing the economy.
Such expectations are also sending U.S. bond yields to their highest levels in years. The two-year Treasury yield shot to 3.23 per cent from 3.06 per cent late Friday, its second straight major move higher. It’s more than quadrupled this year and touched its highest level since 2008.
The 10-year yield jumped to 3.29 per cent from 3.15 per cent, and the higher level will make mortgages and many other kinds of loans for households and for businesses more expensive.
The gap between the two-year and 10-year yields is also narrowing, a signal of increased pessimism about the economy in the bond market. If the two-year yield tops the 10-year yield, some investors see it as a sign of a looming recession.
The pain was worldwide as investors braced for more aggressive moves from a coterie of central banks.
In Asia, indexes fell at least three per cent in Seoul, Tokyo and Hong Kong. Stocks there were also hurt by worries about COVID-19 infections in China, which could push authorities to resume tough, business-slowing restrictions.
In Europe, Germany’s DAX lost 2.6 per cent, and the French CAC 40 fell 2.9 per cent. The FTSE 100 in London dropped 1.8 per cent.
Some of the biggest hits came for cryptocurrencies, which soared early in the pandemic when record-low interest rates encouraged some investors to pile into the riskiest investments. Bitcoin tumbled more than 15 per cent and dropped below $23,254, according to Coindesk. It’s back to where it was in late 2020 and down from a peak of $68,990 late last year.
What's a bear market?
The benchmark S&P 500 finished the day more than 20 per cent below its high earlier this year, entering what investors call a bear market.
Bears hibernate, so bears represent a market that’s retreating, said Sam Stovall, chief investment strategist at CFRA. In contrast, Wall Street’s nickname for a surging stock market is a bull market, because bulls charge, Stovall said.
The last bear market wasn’t that long ago, in 2020, but it was an unusually short one that lasted only about a month. The S&P 500 got close to a bear market last month, briefly dipping more than 20 per cent below its record, but it didn’t finish a day below that threshold.
This would also be the first bear market for many novice investors who got into stock trading for the first time after the pandemic, a period when stocks largely seemed to go only up. That is, they did until inflation showed that it was worse than just a “transitory” problem as initially portrayed.
Michael Wilson, a strategist at Morgan Stanley who’s been among Wall Street’s more pessimistic voices, is sticking with his view that the S&P 500 could fall to 3,400 even if it avoids a recession over the next year.
That would mark another roughly 10 per cent drop from the current level, and Wilson said it reflects his view that Wall Street’s earnings forecasts are still too optimistic, among other things.
With soaring price tags at stores souring sentiment for shoppers, even higher-income ones, Wilson said in a report that “the next shoe to drop is a discounting cycle” as companies try to clear out built-up inventories.
Such moves would cut into their profitability, and a stock’s price moves up and down largely on two things: how much cash the company is generating and how much an investor is willing to pay for it.
The Fed’s moves factor heavily into that second part because higher rates make investors less willing to pay high prices for risky investments.
Economists at Deutsche Bank said they expect the Fed to hike rates by larger-than-usual amounts on Wednesday, again in July, then again in September and a fourth time in November. Just a week ago, before Friday’s wake-up call of an inflation report, Wall Street was debating whether the Fed may take a pause on rate hikes in September.
— with files from The Canadian Press