Everything Selloff Snowballs While Traders Adjust to Fed’s Reality

(Bloomberg) — Investors dealing with a Federal Reserve-induced hangover are suffering as all asset classes deliver losses that aren’t expected to diminish any time soon.

(Bloomberg) — Investors dealing with a Federal Reserve-induced hangover are suffering as all asset classes deliver losses that aren’t expected to diminish any time soon.

Five major exchange-traded funds that track either stocks, bonds or commodities are poised for their first week of tandem losses in a month. Each is down at least 0.8% over four trading sessions, and their synchronized drop puts them on course for the third worst since October.

The widespread declines come as the central bank on Wednesday reiterated that it sees borrowing costs remaining higher for longer given renewed strength in the economy. In projections, 12 out of 19 officials signaled that they see yet another interest-rate hike this year and forecast fewer cuts than had been previously anticipated, due in part to a stronger labor market.

“A lot of investors had been waiting for the Fed to adjust to the market expectations — they were thinking the Fed would adjust their thoughts to be more aligned with the markets,” said Chris Gaffney, president of world markets at EverBank. “And instead the Fed’s holding fast and now the market is having to adjust to the Fed.”

Read more: Fed Signals Higher-for-Longer Rates With Hikes Almost Finished

The S&P 500 Index on Thursday fell for the third straight day, with the index down 2% over that stretch. The Nasdaq 100 fared even worse, losing 3%. And there could be more pain ahead if the Fed sticks to its higher-for-longer message, which could see real yield tick up, spurring a broader selloff, according to HSBC Holdings plc. 

The central bank is more hawkish than the market is and under its higher-for-longer interest-rate scenario, real yields could go up again. Such a setting would be “concerning” and may spark a broad-based selloff similar to the one experienced in 2022, according to HSBC strategists Max Kettner and Duncan Toms. The pair cite data over the last two years showing that higher real yields tend to hurt equities as well as sovereign bonds. 

Only the dollar — and potentially commodities — could be seen as attractive within multi-asset allocations in such a risk-off situation. 

“This would constitute a ‘twisted Goldilocks’ environment, one which is not unambiguously positive equities or carry asset classes, but where the USD is doing fairly well, and cyclical asset classes such as financials in equities or energy are also doing well,” they wrote in a note. “Looking into 2024, we continue to think this is the most likely outcome.” 

But rather than seeing Goldilocks forever — like the one experienced in 2019 and 2021 — there may be some bumps in the road this time around because the turning points for inflation “really matter,” Kettner said, adding that a small drop in consumer prices a decade ago might have gone more unnoticed than a fall to 3% from 4.5% would today.  

In the wake of the Fed’s hawkish pause, US 10-year Treasury yields have risen back above that of global equity yields, said Albert Edwards of Societe General, in a note, adding that yields are at multi-decade highs. The strategist likened the current scenario to 2007, “just before everything fell apart.”

“How much more pain from rising bond yields can equities now tolerate? Maybe none,” he wrote. “Remember the ‘Fed Model’?” he added, referring to a theory positing that stocks need to offer higher yields to stay competitive.

The retreat in both bonds and stocks is particularly painful for a popular strategy that allocates 60% money to stocks and 40% to bonds. A benchmark for the 60/40 model has dropped nearly 2% so far in September. With the 60-day correlation between the S&P 500 and benchmark Treasuries having climbed to the highest level since February, the increasing lockstep moves calls into question the role of fixed income as a hedge when riskier assets slump.

Meanwhile, billions of dollars has flowed into technology funds over the past year, with the sector seeing around $40 billion in cumulative global flows, according to EPFR and Haver data compiled by Deutsche Bank through Sept. 13. Money had also gone into the consumer-goods sector, as well as telecom and industrials. But the current backdrop might not bode well for investors who went all in on tech but underweighted energy, a sector that’s been rallying in recent weeks, according to Bob Elliott, CEO and CIO at Unlimited Funds. 

“Elevated tech valuations, rising long-end yields, and rising oil prices are setting up this positioning for a squeeze,” Elliott tweeted on Thursday.

–With assistance from Katie Greifeld, Isabelle Lee and Denitsa Tsekova.

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