Wall Street stocks had their worst week in nearly four months after comments from Federal Reserve policymakers signaled that the Federal Reserve was well aware of burgeoning inflationary pressures.
The S&P 500 benchmark slipped 1.3 percent on Friday, taking its losses for the week at 1.9 percent. Around 90 percent of the stocks in the blue chip index were lower that day, including stocks from major banks and US oil companies.
Investors have ditched some of their favorite trades of the year, including an earlier foray into stocks in smaller companies that are believed to be particularly vulnerable to economic growth. The Russell 2000 small-cap index posted its largest weekly loss since late January, falling more than 4 percent.
The moves followed comments from Fed chairman Jay Powell on Wednesday, which investors took as a signal that the Federal Reserve would act to curb inflation and that policymakers weren’t just focusing on the tough to support the labor market in the country.
Fed policymakers on Wednesday predicted that interest rates would rise from their record low in 2023 based on their earlier forecast for 2024. That view came after an interview that James Bullard, president of the St. Louis Fed, with CNBC on Friday, where he said the first rate hike could come next year.
The Fed politicians’ shift has rocked what is known as the reflation trade, and instead helped tech stocks that had lost momentum this year. While the tech-heavy Nasdaq Composite fell 0.9 percent on Friday, it ended the week just 0.3 percent.
Inflation expectations were lowered dramatically this week as investors digested the latest Fed decision. George Saravelos, strategist at Deutsche Bank, noted that changing inflation and growth expectations were “in line with the continued resilience of stocks, especially growth stocks,” where lower bond yields make the value of future earnings more attractive.
He added that the fact that volatility in the financial markets “was driven by a tremendous relative rotation from Russell to Nasdaq should come as no surprise”. Saravelos compared it to the market between 2010 and 2019, when growth stock valuations rose due to moderate or low growth and low inflation.
The equity declines accompanied a rally in long-term US Treasury bond prices on Friday as investors saw earlier-than-expected US interest rate hike forecasts as a signal of the central bank’s willingness to control inflation.
The yield on the 10-year US government bond as a benchmark, which is moving in the opposite direction to the price, was 0.06 percentage points lower at 1.44 percent.
That yield is up from about 0.9 percent at the start of the year, but has weakened in recent months as investors view the surge in inflation in the US as temporary. Persistent inflation is undermining fixed income bond yields.
“Markets are now anticipating earlier Fed tightening that could dampen economic growth, hence the decline in the 10-year yield and a rotation away from the a [pandemic] Reopening trading and moving to more secular growth areas of the stock market like technology, ”said Kristina Hooper, Invesco’s chief strategist for global markets.
The dollar also had its best week since April 2020, as short-term government bond yields rose, pricing in expected future rate hikes. The dollar index, which measures the greenback against major currencies, rose 0.4 percent on Friday to 1.9 percent a week.
Gold, valued in dollars and often reversing against the US currency, traded at $ 1,764 an ounce on Friday – a decline of more than 6 percent since Monday, the largest weekly decline since March 2020.
“You have seen the dollar move fairly aggressively because of the restrictive surprise of the anticipated rate hike moves forward,” said Keith Balmer, multi-asset portfolio manager at BMO Global Asset Management. “Most of the market was pessimistic on the dollar prior to this meeting,” he said, as traders had previously expected the Fed to keep monetary policy ultra-loose.