Stocks Continue Descent on Fed Jitters

U.S. equities are under pressure again on Tuesday, revisiting their Friday low amid ongoing pressure against long-term global government bonds. This came amid ongoing uncertainty surrounding upcoming policy decisions next week by the Bank of Japan and the Federal Reserve.

Recently, there has been concern the Fed would push through a rate hike despite recent weakening in the economic data. And out of Japan, there’s concern that BoJ would actively work to boost long-term interest rates in an effort to stem the pain for pensioners and retirement accounts. Investors believe that would badly weaken long-term Japanese government bond prices. Both of these fears were in play again today.

In the end, the Dow Jones Industrial Average lost 1.4% as it once again tests support near the 18,000 level, the S&P 500 Index lost 1.5%, the Nasdaq Composite dropped 1.1% and the Russell 2000 ended the day with a 1.9% loss.


Treasury bonds were weaker, pushing the 10-year yield to 1.73%. That boosted the ProShares Ultra-Short Treasury 20+ Yr (ETF) (NYSEARCA:TBT) recommended to Edge subscribers to an 8.3% gain so far this month. The dollar was stronger, especially against the yen. Gold lost 0.1% for its fifth straight decline. The price of crude oil fell 3%.


All ten sector groups finished lower, with energy and yield-sensitive telecoms leading the way down with losses of 2.9% and 2%, respectively. Apple Inc. (NASDAQ:AAPL) gained 2.6% after T-Mobile US Inc (NASDAQ:TMUS) said iPhone 7 pre-orders have been very strong. JetBlu Airways Corporation (NASDAQ:JBLU) gained 2.4% after reporting a 6.2% rise in August traffic and better-than-expected profitability guidance.

Netflix, Inc. (NASDAQ:NFLX) lost 3% after being downgraded by analysts at Macquarie on international competitive challenges and content acquisition costs.

The day’s selling, which looked like a technically-driven retest of Friday’s lows, was driven by the announcement that Atlanta Fed president Lockhart plans to step down next February at the end of his second term — which traders seemed to interpret as a possible protest resignation amid chatter Fed policymakers are increasingly at odds with each other about the pace and timing of rate hikes.

If so, Lockhart (a non-voter this year) would’ve resigned effective immediately. This looks instead like a typical retirement announcement issued at a time when any Fed-related headlines are market moving events.

Here’s what’s important: After Friday’s market drop, futures market odds of a Fed rate hike next week stand at just 15%. Moreover, Fed watcher Jon Hilsenrath at the Wall Street Journal reaffirmed this expectation of a “no hike” decision by reporting officials lack a consensus for action, pointing to the December meeting as the most likely time for another rate hike.

Separately, and also providing some positivity the market ignored, were reports by Nikkei Asian Review that the BoJ is considering moving short-term rates deeper into negative territory and may drop its estimates of when its 2% inflation target will be reached (effectively extending the timeline for its aggressive monetary policy stimulus).

The report added the bank will discuss ways to limit the side effects of pushing rates deeper below the zero bound, including potentially slightly reducing its long-term bond purchases. A slight move like this will likely be benign; unlikely to roil the JGB market as has been feared.

Much of the market’s volatility has been driven by the unwinding of short-volatility trades from over the summer as well as the hit to risk parity funds since both government bonds and equities are moving lower in unison (cutting the benefit of diversification).

The good news is that bond market derived inflation expectations are rising briskly, a sign that bond traders believe the Fed’s likely “no hike” decision and deeper negative rates out of Japan will likely boost economic growth and thus demand.

Once nerves calm down, weakness in long-term bonds should push cash into equities, as it did when Treasury bonds weakened notably in 2012-2013 as the Fed unleashed its QE3 bond purchase program. The 10-year Treasury yield more than doubled to 3% in late 2013 without any financial catastrophe being unleashed.

Watch for a powerful rebound into options expiration on Friday.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers.

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