From the Fed to Europe’s currency crisis, here’s what’s behind this selloff in financial markets

Traders on the NYSE, June 7, 2022.

Source: NYSE

Stocks fell, bond yields rose and the dollar strengthened on Friday as investors heeded the Federal Reserve’s signal that the war on inflation could lead to much higher interest rates. and recession.

Friday’s sell-off was global, in a week in which the Fed raised rates by three-quarters of a point and other central banks raised their own rates to counter global inflation trends.

The S&P 500 fell more than 2.2% at 3,672 on Friday afternoon, after it temporarily fell to 3,662, well below the June low of 3,666. The Dow Jones Industrial Average is heading for a new close for 2022 low on Friday.

European markets fell more, with FTSE UK and Germany’s DAX both closed down about 2% and French CAC down 2.3%.

Weak PMI Manufacturing and services data from Europe on Friday, and the Bank of England’s warning on Thursday that the country had slipped into recession added to the negative spiral. The UK government also rocked markets on Friday with the announcement of a plan for tax cut and encourage investment to help its economy.

Fed ‘supports’ a recession

Stocks took on an even more negative tone earlier this week, after Fed raised interest rates on Wednesday by 3/4 points and forecast it could raise deposit rates to as high as 4.6% early next year. That rate is now 3% to 3.25%.

“Inflation and rising rates are not a U.S. phenomenon. It’s also a challenge for global markets,” said Michael Arone, investment strategist at State Street Global Advisors. “Obviously the economy is slowing down but inflation is rising and the central bank is forced to tackle it. Turning around Europe, the ECB [European Central Bank] are going from negative to positive at a time when they have an energy crisis and war in their backyard. “

The Fed also forecasts that the unemployment rate could rise to 4.4% next year, from 3.7%. Fed Chairman Jerome Powell steadfastly warns the Fed will do what it needs What to do to crush inflation?

“Basically endorsing the idea of ​​a recession, Powell kicked off the emotional phase of the bear market,” said Julian Emanuel, head of equities, derivatives and quantitative strategy at Evercore ISI. . “The bad news is that you’re seeing and you’ll continue to see it in the near-term as the indiscriminate selling of virtually any asset. The good news is that it tends to be an end game of almost every bear market we’ve seen. witnessed, and it will take place in September and October, where it used to be the normal state of affairs.”

Recession worries also brought commodity complexity down, with metals and farm commodities both selling off across the board. West Texas Intermediate Oil Futures Contract fell about 6% to just above $78 a barrel, the lowest price since early January.

Europe, Pound Sterling Impact

“European bonds, while they are bearish, are rallying again, but the UK drop remains a disaster,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “I feel like this morning, in the short term, could have invested in bonds. But we’ll see. Stock investors are clearly still very nervous and the dollar is still at its highest level in the world. day.”

The dollar index, largely affected by euro hit a new 20-year high and rose 1.2% at 112.71, while the euro fell to $0.9721/dollar.

Arone said other factors are playing out globally as well. Arone said: “China adopted the Covid strategy and the common prosperity has slowed down the economic growth rate. “They’ve been slow to come up with easy monetary policy or additional fiscal spending at this point.”

Globally, the common problems are a slowing economy and high inflation with central banks engaged in curbing high prices, Arone said. Central banks are also raising interest rates at the same time they are ending their bond-buying programs.

Strategists say the US central bank has particularly shaken markets by forecasting new interest rates higher, at a level they believe it will stop rising. The Fed’s projected high 4.6% water rate for next year is considered the “final interest rate,” or final interest rate. Still, strategists say that’s fine until inflation clears up and futures funds for early next year are racing above that level, up 4.7 percent on Friday morning.

“Until we get a picture of interest rates falling and inflation starting to fall, until that happens, more volatility is expected ahead,” Arone said. “The fact that the Fed doesn’t know where they’re going is an uncomfortable place for investors.”

Watch for signs of market stress

Boockvar said market moves are tough because central banks have been making easy money for years, since before the pandemic hit. He said interest rates have been held back by global central banks since the financial crisis, and that until recently, interest rates in Europe were negative.

“All of these central banks have been sitting on a beach ball in a swimming pool for the past 10 years,” he said. “Now they’re going out of the ball and it’s going to go pretty high. What’s happening is the currency and debt emerging markets are trading like the emerging markets.”

Marc Chandler, chief market strategist at Bannockburn Global Forex, said he thinks the market is starting to price in a higher end-of-term interest rate for the Fed, up to 5%. “I would say that the forces that have been unleashed by the Fed are encouraging the market to re-price interest rates eventually. That’s certainly one of the factors that unleashed this volatility,” he said.

Higher closing rates will continue to support the dollar against other currencies.

“The bottom line is that despite our problems here in the US, with the Fed revised down this year’s GDP by 0.2%, stagnation, we still sound like a better bet when you consider alternatives”.

Strategists say they see no concrete signs, but they are monitoring markets for any signs of stress, particularly in Europe, where rates are volatile.

“It’s like Warren Buffett said,” Chandler said. When the tide goes out, you’ll see who isn’t wearing a swimsuit. “There are places that have benefited from low rates for a long time. You don’t know about them until the tide goes out and the rocks come out.”

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