Stocks plummeted as recession fears rocked trading

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US stocks ended in a bear market, Treasury yields rose to levels not seen in a decade and the dollar rallied as the aftermath of a hot inflation rate further rattled global trade already rocked by worries that the Federal Reserve could plunge the economy into recession.

Another brutal sell-off sent the S&P 500 to a 15-month low and down more than 20% from its January peak. Highly rated tech stocks bore the brunt of the slide, with the Nasdaq 100 plunging about 4.7%. The Cboe volatility index jumped above 30 and the futures curve inverted in a rare instance where traders were pricing in more uncertainty in the here and now than they have been in three months. Speculative areas of the market, bloated by years of Fed and government largesse, plummeted. Profitless software companies, newly listed companies and blank check companies have all been sold. Bitcoin crashed below $24,000 after a lending platform shut down operations.

Credit markets continued their historic repricing of yield curves. 10-year Treasury yields climbed 20 basis points to their highest level since 2011, while 2-year Treasury yields jumped to levels last seen before the 2008 crisis. The cost of protecting investment-grade debt from default rose to a two-year high as a closely watched segment of the US curve inverted amid recession fears. Only the dollar offered respite from the sell-off, staging its biggest four-day rally since the pandemic began.

“It’s getting a little uglier,” said Victoria Greene, chief investment officer at G Squared Private Wealth. “Equities will have a very hard time recovering if the Fed continues to apply hawkish pressure. There is no way you can slam on the brakes with inflation without slamming on the brakes economically. It’s weird that we still have recession deniers.”

Financial markets are bracing for the Fed to turn very hawkish after Wednesday’s meeting. Traders are now pricing in a tightening of 175 basis points through September – implying a hike of two half and one 75 basis points. If that happens, it would be the first time since 1994 that the Fed has acted at such an aggressive pace. Officials will be muzzled ahead of the decision in two days and Chairman Jerome Powell’s conference, where characterizing inflation and long-term projections for the Fed funds target — the so-called dot plot — will be crucial.

As the Fed tries to bolster its credibility on inflation, it could mount a more drastic hike if it’s forced to demonstrate a “Volcker moment,” said Steven Englander, global head of currency research for the Group of Ten at Standard Chartered Bank. He was referring to Fed Chairman Paul Volcker, who crushed inflation with a series of historic rate hikes beginning in 1979. With that possibility, Mr. Englander predicts a 10 percent chance of a 100 basis point hike on Wednesday – with his baseline still up half a percentage point.

The dramatic movements in the world’s largest bond market mean further problems for battered US stocks. Recent history shows that stocks tend to swoon when the 10-year Treasury yield hits 3%, like in early May and late 2018, according to DataTrek Research’s Nicholas Colas. It surpassed 3.3% on Monday.

According to strategists at Morgan Stanley, Goldman Sachs Group and BlackRock Investment Institute, stocks still do not fully reflect risks to corporate earnings. Weaker consumer demand and aggressive Fed tightening in an attempt to combat the hottest US inflation in four decades could hurt earnings and, in turn, stock prices further. For Evercore strategist Julian Emanuel: “What’s been missing for the past few months is some sort of ‘cathartic flush’ where you get the VIX above 40, which is one of the things you need to at least hit a trading floor. “

Equities’ last bulwark is about to collapse judging by CEO sentiment. A Conference Board survey of corporate sentiment showed that CEO confidence fell sharply for the fourth consecutive quarter in the second quarter of the year. Similar skepticism has always accompanied a recession in earnings in the past, wrote Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.

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