Stocks were a sea of red this morning as Wall Street grappled with the growing consensus that the Federal Reserve is unlikely to cut interest rates in the near term. The S&P 500 retreated by 1.2%, the Dow Jones Industrial Average shed around 330 points, a 1.0% drop, and the tech-heavy Nasdaq Composite also declined by 1.2%. Despite starting the week on a positive note, all three major indices are now on track for a losing month.
Fed policymaker Neel Kashkari weighed in yesterday, stating that the U.S. economy’s surprising resilience means the central bank will likely need to hike rates again to cool inflation. This sentiment echoes recent comments from other Fed officials. The 10-year Treasury yield hovered around 4.53%, near its highest levels since 2007, pushing the dollar to a new 10-month peak.
Adding to the market’s concerns, fresh data today revealed a drop in consumer confidence for September and a record rise in U.S. home prices in July. JPMorgan CEO Jamie Dimon issued a stark warning, cautioning that markets might not be prepared for a worst-case scenario where the Fed hikes rates to 7% amid stagflation. “We urge our clients to be prepared for that kind of stress,” Dimon said, emphasizing that a hard landing remains a risk for the U.S. economy.
Dimon’s comments stand in contrast to the prevailing view that rates will stay higher for longer to contain inflation amid better-than-expected economic activity. Money markets, however, are already pricing in rate cuts for next year. “If they are going to have lower volumes and higher rates, there will be stress in the system,” Dimon noted, adding that the difference between a 5% and 7% rate would be more painful than the previous jump from 3% to 5%.
The U.S. dollar continued its ascent today, influenced in part by hawkish comments from Fed officials and Dimon’s warning. Christopher Wong, an FX strategist at Oversea-Chinese Banking Corp, pointed out that a key rate of 7% would have severe implications for American businesses and consumers. Economists currently place the probability of a U.S. recession within the next year at 55%, a figure more optimistic than Bloomberg Economics’ prediction of a downturn as early as this year.
Charlie Jamieson, CIO at Jamieson Coote Bonds, echoed Dimon’s sentiment: “The world is certainly not prepared for a 7% Federal Reserve funds rate. At that level, we would expect a deflationary asset unwind; it would burst a lot of asset bubbles; it just simply wouldn’t be sustainable.”
Further darkening the mood was Moody’s warning that a government shutdown would negatively impact the U.S. credit rating. With the Sept. 30 budget deadline looming and no deal in sight, history suggests that this standoff could send shockwaves through the stock market. Market participants are now looking ahead to key economic data releases later this week, including Thursday’s update on U.S. second-quarter GDP and Friday’s fresh reading on PCE inflation, the Fed’s preferred measure.
Yes, stocks continue to look oversold, but that won’t save bulls from an even deeper selloff should a government shutdown emerge, which is looking more likely with each passing day.