Markets sink into bear territory as Fed ramps up rate hikes

MANHATTAN (CN) — Wall Street took another bath this week on news that the Federal Reserve is not only not backing off its hawkish tone but indeed is becoming more stalwart in its decision to keep hiking rates.

The Dow Jones Industrial Average ended Friday more than 6,000 points lower than at the start of the year, roughly a 20% decline, with the S&P 500 and Nasdaq seeing similar drops during that same period.

Massive market losses kicked off the week on Monday, with the Dow plummeting 876 points. While indices picked up a bit on Friday and had a midweek breather, all three were down sharply from last week by Friday’s closing bell : The Dow lost 1,508 points, the S&P 226 points, and the Nasdaq 542 points.

Investors were briefly cheered on Wednesday after the Fed raised interest rates by 0.75% — the first time it did so going back to 1994 — which initially caused markets to rally. The Dow closed about 300 points higher on Wednesday, while the S&P and Nasdaq gained roughly 50 points and 200 points for the day, respectively.

The gains were short-lived, though, as on Thursday markets fell once again. The Dow shed more than 700 points to dip under 30,000 points for the first time in more than a year, while the S&P 500 and Nasdaq declined 3.25% and 4%, respectively.

“Markets believed and applauded Chairman Powell’s resolve to fight rising inflationary pressures — and that’s the problem,” said Quincy Krosby, chief equity strategist for LPL Financial, adding that “concerns are mounting about whether the Fed is headed towards a policy mistake, otherwise known as ‘breaking something.’”

The Fed in its statement continued to blame the invasion of Ukraine by Russia for persistent inflation and supply-chain disruptions, as well as Covid-related lockdowns in China. The federal funds rate currently stands at 1.5% to 1.75%.

During the press conference after the announcement, Fed Chair Jerome Powell said further 0.75% hikes are likely at the central bank’s next meeting in July, though he said he does not expect such hikes to be common.

Powell followed those comments with a speech on Friday in which he assured investors of the Fed’s “strong commitment to our price stability mandate,” and said he is “acutely focused on returning inflation to our 2% objective.” The Fed also in its biannual report to Congress said it had an “unconditional” commitment to restoring price stability.

The report to Congress also had the Fed stating that consumer spending remained strong, and that it expects gross domestic product to rise moderately in the second quarter. In its latest economic projections, however, the Fed again slashed its GDP expectations for the year, from 2.8% back in March to 1.7%. The projection for 2023 also declined, from 2.2% to 1.7%, though the projection for 2024 is relatively unchanged at 1.9%.

The Federal Reserve Bank of Atlanta already has decreased its GDP expectations to 0% for the remainder of the year, indicating a recession. The bank had previously forecast GDP growth around 1%, with its predictions steadily declining since mid-May. GDP already shrank by 1.4% during the first quarter of the year.

The Fed’s newest projections point to a 3.8% federal funds rate in two years, the highest it has been since 2008. Further, Treasury yields are inching upward, slowing consumer spending, and minimal wage gains in the face of rising inflation has analysts worried about a recession.

“The depth of each of these [factors] will determine if stocks decline 5% or worse after already correcting over 20%,” James Vogt of Tower Bridge Advisors wrote. “It doesn’t guarantee a recession, but odds are certainly much higher today than a few months ago.”

Abroad other central banks also have hiked rates to try to combat inflation, though less dramatically than the Fed has. On Wednesday the Bank of England increased rates to 1.25%, its fifth rate hike since late 2021. “If the Bank of England were looking for reasons why people have so little confidence in them, they need to look no further than the events of the last few days,” CMC Markets analyst Michael Hewson wrote in an investors’ note on Wednesday.

The European Central Bank also has recently indicated it plans to increase interest rates by 25 basis points at its next meeting in July and said that “a gradual but sustained path of further increases in interest rates will be appropriate.”

Investors were also greeted with less-than-optimal retail sales data earlier in the week, which showed a 0.3% decrease in monthly sales in May, as well as downward revisions to previous months’ gains.

Some believe the retail numbers portend further pain. “Nagging inflation and persistently high gas prices are taking a bite out of consumers’ wallets,” said Jeffrey Roach, chief economist at LPL Financial. “We expect spending to further downshift during the latter half of this year.”

Overall retail sales were laden by a 3.5% decrease in auto sales last month, though that can be chalked up to supply-chain issues out of China and not a slump in demand, analysts say. Andrew Hunter, senior U.S. economist at Capital Economics, told clients on Wednesday that “a rebound in real spending looks unlikely” over the summer but that the 3% expected growth is “a long way from the collapse being predicted by the usual bearish suspects.”

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