US Stocks and Bonds Feel Impact of Fed’s ‘Higher for Longer’ Message

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US stocks and government bonds are experiencing their most challenging month of the year as investors respond to the US Federal Reserve’s announcement that interest rates will remain higher for a longer period than previously anticipated.

The S&P 500, Wall Street’s benchmark stock index, has fallen by over 5% in September, putting it on track for its first quarterly loss in 12 months.

Last week, the US bond market suffered a sharp decline after the Fed indicated that it would be slowing down rate cuts in the coming years. This has led to a significant increase in the yield on 10-year Treasury bonds, which is set for its biggest monthly surge in a year.

Investors are coming to the realization that the phrase “higher for longer” actually means what it implies, leading to a negative impact on market sentiment, according to Mark Dowding, chief investment officer at RBC BlueBay Fixed Income.

Previously, traders had expected interest rates to be around 4.2% by the end of 2024 but are now projecting rates of 4.8% by that time. Kevin Gordon, senior investment strategist at Charles Schwab, points out that the market has consistently misjudged Fed policy this year, and now there is growing acceptance that the Fed’s intentions are genuine.

The anticipation of prolonged high interest rates has caused a downturn in equities as higher bond yields make it difficult for investors to find attractive returns. Moreover, this shift in rates could have a negative impact on the real economy.

Although the S&P is still up 11% year-to-date, its performance has been driven by a small number of tech stocks that experienced significant gains earlier in the year. The index has fallen into negative territory when equally weighted.

In addition to equities, corporate debt markets have also been affected, as concerns rise over highly-indebted companies struggling to refinance their borrowings in the face of higher rates.

Unlike the eurozone and the UK, where fears of a downturn are prominent, the Fed is responding to strong economic data and a robust labor market. This divergence in central bank policy has contributed to market uncertainty.

Sonal Desai, chief investment officer at Franklin Templeton Fixed Income, highlights the market’s recognition that a recession is not imminent, given strong economic data and the Fed’s revised forecasts for unemployment and growth.

However, concerns remain that the lagged effect of Fed tightening may catch up with the economy in the future, leading to a potential recession despite the current positive indicators.