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Sep. 22, 2022 at 4:31 PM EDT

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Updated Sep. 22, 2022 at 8:22 PM

Markets Drop on Recession Fears

Stocks tumbled Wednesday after the Federal Reserve raised interest rates again.

Stocks tumbled Wednesday after the Federal Reserve raised interest rates again. (Getty Images)

The stock market continued its drop Thursday afternoon with technology stocks leading the way. The fall comes after the Federal Reserve lifted rates and signaled it would remain aggressive in its fight against inflation.

The Dow Jones Industrial Average slipped 108 points, or 0.4%, while the S&P 500 declined 0.9%, and the Nasdaq Composite fell 1.4%. Higher rates make future profits less valuable – and many fast-growing technology companies are valued on the basis that they’ll churn out a bulk of their profits years down the line.

"The Fed has succeeded in convincing markets that they will remain aggressive with fighting inflation,” wrote Edward Moya, senior market analyst at Oanda.

The indexes dropped more than 1.1% Wednesday after the Fed’s announcement. The Fed lifted the federal funds rate by three-quarters of a percentage point on Wednesday, though that was expected. The point of pain for the market was that the majority of Fed members see the benchmark lending rate going above 4.5% in 2023, which was well above prior exceptions for the peak fed funds rate. The Fed remains adamant that it needs to kill high inflation even if it means forcing the economy into recession.

That was clear from the bond market, where short-term bond yields were moving higher. The 2-year Treasury yield, a barometer for the fed-funds rate in the future, has gained to 4.124%, a new multi-year high. The yield on the benchmark 10-year Treasury note also rose to 3.705%, a new multi-year high. The spread between the 2-year and 10-year remains deeply “inverted,” which is when the 2-year yield is higher than the 10-year yield. This “inverted yield curve” is a long-established indicator for recession because it indicates that higher rates will destroy economic demand and inflation for the longer-term.

"That is a sign that — it’s really about the anticipated impact of the monetary tightening of long-term growth and inflation expectations,” said Christoph Schon, senior principal of applied research at Qontigo.

The U.S. market, though, is partly responding to rate hikes from other central banks as well. The Bank of England raised its short-term rate by a half a percentage point Thursday morning. That sent the U.K. 2-year Gilt yield up to 3.498%, also a new multi-year high. The U.K.’s FTSE 100 dropped 1.1%.

The overseas rate hikes play a part in pushing U.S. yields higher. When yields on foreign bonds rise, it makes the higher-yielding U.S. bond market slightly less attractive, forcing money out of U.S. bonds, lowering their prices and lifting their yields. Higher U.S. yields are also keeping the dollar elevated. Investors buy dollars when they’re ready to buy higher-yielding U.S. bonds. The U.S. dollar index rose 0.5% to above 111.

That is a concern for the stock market because it threatens corporate profits. U.S. companies that generate sales overseas see fewer dollars when they translate those sales back into a stronger dollar.

But the overarching worry for the stock market right now is earnings. The economic damage from higher rates plus a stronger buck could bring earnings down from current expectations. Forecasts have already dropped across sectors – and more of the same could be on the way. Recently, inflation itself has lowered demand in some businesses and caused soaring costs in others. But it sometimes takes some time for consumers to spend even less after rates move upwards, so there could be another wave of downward earnings revisions.

"Monetary policy works with a long and variable lag,” wrote Christian Hoffmann, portfolio manager at Thornburg Investment Management.

DJIA

DJIA (Dow Jones Global)

S&P 500

SPX (S&P US)

Nasdaq

COMP (Nasdaq)

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