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Wall Street selloffs intensified last week, driven by sticky inflation numbers and hawkish Fed talks, which turned traders and investors away from stocks.
All major equity indexes ended the week sharply lower, with S&P 500 dropping 1.9%, the Dow Jones Industrials losing 1.6%, and the tech-heavy Nasdaq plunging 2.4%.
Market participants were discouraged by sticky inflation numbers at home and abroad, released during the week.
At home, Fed’s favored inflation gauge, the Personal Consumption Expenditure Index (PCE), rose at an annual rate of 4.9% in August, ahead of the 4.7% markets had expected and up from 4.7% in July.
The high inflation numbers confirm that price hikes are still sticking around. Moreover, these numbers came when the U.S. labor market remained hot. Jobless claims dropped to 193,000 in the previous week, far more than the 215,000 markets expected, and reaching a five-month low.
Sticky price hikes and a hot labor market pressure the Fed to continue raising interest rates, something Fed officials re-iterated during the week.
Speaking at a London conference on Tuesday, St. Louis Fed President James Bullard said there are more interest rate hikes ahead. Cleveland Fed President Loretta Mester, Chicago Fed President Charles Evans, and Minneapolis Fed President Neel Kashkari made similar statements.
They reaffirmed Federal Reserve Chair Jerome Powell’s hawkish message following the last FOMC meeting that the Fed is prepared to hike rates until inflation declines to its official target of 2%.
Overseas, eurozone inflation ran at an annual rate of 10% in September, up from 9.7% in August. It’s putting pressure on European Central Bank President Christine Lagarde to accelerate the pace of rate hikes in the eurozone, even as the 19-member bloc economy is heading into a recession.
Sticky inflation numbers and hawkish talk by Fed officials dashed traders and investors’ hopes that interest rates will peak by the end of the year. Thus, selloffs continued, especially in market areas where equity valuations remain high, like the Nasdaq.
But with significant indexes down anywhere between 20 to 30%, isn’t the worst for U.S. equities over?
According to one measure, the gap between the S&P 500 earnings yield and the 10-year bond yield, the answer is yes. Historically, this gap is roughly 200 bps, which seems to be very close to being the case recently. But that can change depending on new data, which will provide further evidence on inflation and the overall economy.
Bob Bilbruck, CEO of B2 Group and Captjur, a strategic consulting and business services firm, remains pessimistic.
“Inflation has just started to hit us, and I think investors are a little late to the party that we are in a recession with high inflation,” he told International Business Times in an email. “The only thing missing to put us into a true period of stagflation is high unemployment.”
Jeremy Bohne, founder of Paceline Wealth Management, is less pessimistic. He thinks markets have already discounted rate hikes reaching 4.25% by the end of 2022.
“People are still trying to wrap their heads around whether this results in a recession, most likely during 2023 if it does occur,” he told IBT.
Bohne reiterated the view circulated on Wall Street these days that a recession is the only means to bring inflation down, as the old villain is already embedded in wages.
“So to fix this, the FED needs to cause the unemployment rate to rise to slow wage inflation,” he added.
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