US stocks and government bonds are facing their worst month of the year as investors react to the US Federal Reserve’s indication that interest rates will remain higher for a longer period of time. The S&P 500 stock index has dropped more than 5% in September, putting it on track for its first quarterly loss in 12 months. The retreat in the bond market has accelerated after the Fed announced it would cut rates more slowly in the coming years than what investors had anticipated. This has caused the yield on 10-year Treasuries to reach its highest level since 2007, leading to concerns about the impact on equities and corporate debt markets.
Investors were initially expecting interest rates to rise to around 4.2% by the end of 2024, but now they are betting on rates of 4.8% by that time. They have now realized that “higher for longer” actually means higher rates will persist for an extended period. This shift in expectations has impacted equity markets as higher bond yields make it more challenging for investors to find returns, and it can also negatively affect the real economy. The S&P 500 has been supported by a handful of heavily-weighted tech stocks, but the equal-weighted version of the index recently fell into negative territory for the year. Additionally, concerns have arisen in the corporate debt markets as heavily-indebted companies may struggle to refinance their loans with higher rates.
The Fed’s reaction to strong economic data and a strong labor market, in contrast to the eurozone and the UK, where fears of an economic downturn are greater, has caused the market to finally realize that a recession is not imminent. Fed officials have reduced their forecasts for unemployment and increased their growth predictions. While the central bank is maintaining its main interest rate, projections from policymakers suggest that there may be one more increase this year. Rising oil prices have also contributed to market concerns about persistent inflation and tight monetary policy. Despite the positive economic data, some investors worry that the lingering effect of Fed tightening could eventually lead the economy into a recession as we move into 2024.