Wall Street sentiment chilled Wednesday as overwhelming futures market odds of a rate hike at the Federal Reserve March policy announcement sent U.S. equities lower.
According to the CME FedWatch tool, traders are currently assigning a 93% chance that Fed Board Chair Janet Yellen will raise rates by another 0.25% — just three months after the last rate hike — dramatically quickening the pace of policy tightening.
In the end, the Dow Jones Industrial Average lost 0.2%, the S&P 500 gave back 0.3%, the Nasdaq Composite lost 0.3% and the Russell 2000 finished 0.6% lower. Treasury bonds enjoyed a respite from recent selling, the dollar was mostly stronger, gold finished little changed and oil extended its recent selloff down another 1.4%.
The drop in crude oil boosted the ProShares UltraShort Crude Oil (NYSEARCA:SCO) recommended to Edge subscribers another 1.5% to bring its total gain since recommended on Jan. 11 to 20%.
The hit to crude oil marked the seventh consecutive loss and was spurred by the release of OPEC’s monthly report showing Saudi Arabia self-reporting a 263,000 barrel per day increase in production — taking overall output back over the 10 million barrel per day mark. Also weighing on sentiment were comments from Kuwait’s oil minister that he sees a risk of oil dropping back to the $45-a-barrel threshold as a result of increased U.S. shale production.
Exacerbating all this is near-record net-long positions by oil speculators; setting the stage for panic selling that reinforces price weakness. No surprise then that energy stocks led the laggards, down 1.1% as a group followed by industrials and materials.
Valeant Pharmaceuticals Intl Inc (NYSE:VRX) fell 10.1% after Pershing Square (Bill Ackman’s fund) sold 27.2 million shares representing a $4 billion loss for the fund. Pandora Media Inc (NYSE:P) fell 6.4% amid a leadership battle. And smartphone glassmaker Corning Incorporated (NYSE:GLW) fell 3.1% after a downgrade from Goldman Sachs on valuations concerns.
Turning back to interest rates.
Over the past ten years, the Fed has raised rates only twice. Now, based on both the Fed’s own rate hike forecast and futures market odds, a total of three rate hikes are expected before the end of the year. All this is being motivated by ongoing evidence of labor market tightening, bubbling inflationary pressure and off-the-charts optimism reflected in consumer, investor and business survey data.
A hawkish turn by the Fed would reverse the long standing assumption our central bank would be dovish always and everywhere — using any excuse to hold interest rates as low as possible. This dynamic has helped push financial asset valuations to historic highs across the board. Bonds are expensive. Stocks are expensive. Treasuries are expensive.
But the specter of a higher rate environment has begun the process of unwinding all this, with bonds getting hit with weakness over the past week. Watch for stocks to fall in sympathy once the Fed announces the rate hike and updates its economic forecasts, firming up the three-hikes-in-2017 assumption.
Anthony Mirhaydari is founder of the Edge (ETFs) and Edge Pro (Options) investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers. Redeem by clicking the links above.