S&P 500 drops 2% in worst day since May

The prospect of the Federal Reserve not reaching so deep into its bottomless pockets is starting to hit investors.

The S&P 500 fell 2% on Tuesday – the worst one-day drop for the U.S. benchmark since May – as investors faced the expected cut in huge bond purchases the central bank has made since May. start of the pandemic.

“The sell-off highlights the extent of nerves in the markets surrounding the Fed’s moves,” said Fiona Cincotta, senior financial markets analyst at Forex.com.

The upcoming slowdown in bond buying is a sign of the Fed’s confidence that the economy is recovering from the upheaval of the pandemic. But, Ms. Cincotta noted, other factors still make Wall Street suspicious.

“There is also a combination of rising energy prices, fears that inflation is no longer entrenched in these high levels and that consumer confidence is slowing,” she said.

The fall continued until Wednesday’s Asian trading day, although investors signaled that confidence could return.

Shares in Japan were down more than 2.6% as of noon. But losses in other Asian markets, such as Hong Kong and mainland China, were more moderate. Futures markets were signaling that Wall Street would open slightly higher.

The trigger for Tuesday’s drop, which hit all sectors, was a rise in the yield on the benchmark 10-year Treasury bond. As the Fed prepares to slow its purchases as early as November, investors have sold off bonds before demand weakens. On Tuesday, that pushed the 10-year yield to 1.54%, its highest level since June.

Even though the Fed has said it doesn’t plan to raise interest rates for months or years, government bond yields are the basis of borrowing costs across the country. economy. When bond prices fall, yields rise – a move that can hamper the performance of the stock market because it makes bond ownership more attractive and may discourage riskier investments.

Technology stocks, particularly sensitive to the prospect of rising interest rates, were hit hard on Tuesday. The tech-heavy Nasdaq composite fell 2.8%, its biggest drop since February.

Higher rates would make borrowing more expensive for small businesses, and rising yields have hit stocks in several high-profile stocks. Etsy, the online craft market, fell 6% and Shopify fell more than 5%. Both companies have skyrocketed during the pandemic.

“With tech stocks, you’re betting that a company will have a breakthrough in years,” said Beth Ann Bovino, chief US economist at S&P Global. “If interest rates rise today, the value you will receive years from now is discounted. “

The biggest tech stocks – especially Amazon, Apple, Microsoft, Google and Facebook – have a big influence on the broader market and helped push the S&P 500 down. Apple fell 2.4% and was the most successful of the tech giants. Amazon fell 2.6% while Microsoft, Facebook and Google fell more than 3.5%.

But the declines affect many sectors. Energy stocks were the exception, recovering from the rise in oil prices earlier in the day. Schlumberger, ConocoPhillips, Halliburton and Exxon Mobil were among the best performing stocks on the S&P 500, although some of their gains faded when oil futures fell in the afternoon.

The Delta variant of the virus remains a concern for investors, as persistent supply chain bottlenecks have affected everything from auto production to school lunches. In Washington, lawmakers remain deeply divided over infrastructure spending and the expansion of social programs.

And another pressing fight is brewing to raise the country’s debt limit – a dispute that could trigger a government shutdown. Treasury Secretary Janet L. Yellen on Tuesday warned lawmakers of the “catastrophic” consequences if Congress did not address the debt ceiling by October 18.

The malaise is apparent in the performance of stocks over the past four weeks. The S&P 500 is approaching a 4% decline for September, ending seven straight months of gains. The winning streak had pushed stocks up more than 20% as investors largely seemed to ignore any bad news.

Hard times have usually involved the Fed. Tuesday’s trading echoed the volatility at the start of the year, when a jump in rates rocked financial markets. The hike came as traders feared higher inflation could push the Fed to raise rates sooner than expected.

“There’s no question that the equity market doesn’t like higher rates – there’s just no debate about it,” Ralph Axel, director of US rate strategy at Bank of America.

Lauren Goodwin, an economist at New York Life Investments, wrote in a note to clients that investors have started to seek safer investments while weighing concerns including the fight against the debt ceiling and regulatory measures in China.

The Chinese government has shown signs of drastically abandoning the policies that have guided its economy for much of the past decade, by tightening regulations on topics such as online gaming and data sharing by tech companies. And Beijing has so far been reluctant to bail out Evergrande Group, a beleaguered residential developer with $ 300 billion in debt, another shift from usual policy.

But, Ms. Goodwin wrote, risks like this “should have little impact on the broader fundamental environment.” Instead, she said, the driving forces of the market for the near future would remain those that have done so for the past 18 months: the spread of the virus, government spending and Federal Reserve decisions. .

“The path will depend heavily on our three very uncertain drivers – the pandemic, monetary policy and fiscal policy,” she wrote.

While the slowdown in bond buying will start sooner rather than later, the Fed’s main policy interest rate – its most powerful and traditional tool – remains close to zero. And Fed Chairman Jerome H. Powell and his colleagues have signaled that the central bank is far from raising interest rates because it wants to see the labor market regain its full strength before it does.

“The test for raising interest rates is significantly higher,” Powell said at a Senate Banking Committee hearing on Tuesday. What the Fed wants to see, he said, is a “very strong” job market: “The kind of thing we saw before the pandemic hit.”

Jeanne Smialek and Matt phillips contributed report.

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