(Bloomberg) -- Stocks fell after Jerome Powell signaled there’s no need for the Federal Reserve to rush with rate cuts as the economy is holding up.
The equity market closed near session lows, US two-year yields spiked and the dollar climbed after Powell’s remarks. Traders dialed back bets on a December rate reduction to around 55% — from 80% in the previous day.
“Powell’s speech was hawkish,” said Neil Dutta at Renaissance Macro Research. “I think they will still cut in December since policy remains restrictive and they want to get to a neutral setting. That said, on the economy, I think Powell (and the broader consensus) is complacent. There is more downside risk in the near-term than is being appreciated.”
To Quincy Krosby at LPL Financial, while it’s expected that the last mile towards price stability will be bumpy, Powell reminded markets that once again the Fed will not deliver the series of rate cuts they want, unless of course the labor market deteriorates.
Several policymakers have urged a cautious approach to further rate cuts in comments this week, in light of a strong economy, lingering inflation concerns and broad uncertainty. Their comments come at a time when the equity market is showing signs of fatigue following a post-election surge that spurred calls for a pause, with several measures highlighting “stretched” trader optimism.
The S&P 500 dropped 0.6%. The Nasdaq 100 slipped 0.7%. The Dow Jones Industrial Average lost 0.5%. Automakers like Tesla Inc. and Rivian Automotive Inc. slumped as Reuters reported President-elect Donald Trump plans to eliminate the $7,500 consumer tax credit for electric-vehicle purchases. Walt Disney Co. jumped on a profit beat.
Treasury two-year yields rose seven basis points to 4.36%. The Bloomberg Dollar Spot Index added 0.3%.
Equities lost steam after a strong post-election rally that reflected optimism that Trump’s agenda would support corporate growth.
While many investors seem reluctant to sell just yet, caution is warranted, according to Fawad Razaqzada at City Index and Forex.com. The S&P 500 is clearly overbought by several metrics, signaling that a correction or consolidation may be due, he noted.
“Although a full-fledged selloff appears unlikely without the index first breaking multiple support levels, current conditions suggest a modest pullback may be in order for the S&P 500,” Razaqzada added. “For seasoned traders, a short-term pullback could offer buying opportunities, though a clear trend reversal signal has yet to emerge.”
The S&P 500 may reach 6,100 before year-end amid enthusiasm over the Republican sweep of the White House and Congress, but pushing beyond that level may be challenging in the near term, according to Mike Wilson at Morgan Stanley. The gauge closed at 5,949.17 Thursday.
The market may be pressured by any backup in benchmark borrowing rates, or expectations of less aggressive monetary easing by the Fed, Wilson said in an interview to Bloomberg Television, adding that pullbacks will probably be seen as buying opportunities.
The US equity benchmark is likely to grind higher into year-end — with a market melt-up possible, but not a base case, according to UBS Group AG strategists including Maxwell Grinacoff.
With Commodity Trading Advisor funds already positioned max long, marginal upside from option dealer short gamma positioning and the Trump re-election well priced, a market grind higher is a more likely scenario, they noted.
Societe Generale SA strategists including Andrew Lapthorne see US equities as “undeniably expensive” but say valuation conversations “are increasingly rare.” The US represents about 74% of the MSCI World market cap, also a record high. “This is almost entirely down to the valuation premium, without which the US would be closer to 50% of MSCI World.”
While the stock market has mostly ignored the recent move higher in bond yields as economic growth holds up, it’s still something worth keeping an eye on.
Higher odds of a December Fed cut increase the chances that an already firm economy will strengthen further, according to Dennis DeBusschere at 22V Research. Economic data needs to stay consistent with growth of around 2.5% (or lower) for 10-year yields to stay where they are, he added.
“Our call is 10-year yields remain around current levels, but growth above 2.5% will lead to higher yields and a potential break above 4.55%,” DeBusschere noted. “That level of yield would be a headwind for small caps, debt risk names, and other riskier factors as it happens.”
In fact, while Trump’s victory in the US election propelled the Russell 2000 of smaller firms back toward levels last seen three years ago, an overhang from interest rates remain a hurdle.
Morgan Stanley’s Wilson this week said a key risk for small caps present now that was not in 2016 is the market’s negative correlation to rates, while it was positive eight years ago when Trump first captured the White House. The Russell 2000 rose 60% during Trump’s first term, though still trailing the S&P 500 and the Nasdaq 100 indexes.
“In other words, in today’s later-cycle environment, these cohorts’ adverse sensitivity to rising rates is greater than it was in that period,” he warned clients in a note. “Should rates see more upside post the election, these cohorts could be held back from a relative performance standpoint.”
The potential for renewed inflation is being considered, though even hotter US data is unlikely to derail the risk-on mood since there’s another inflation print in December ahead of the next Fed meeting, according to JPMorgan Chase & Co.’s Andrew Tyler.
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This story was produced with the assistance of Bloomberg Automation.
