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Nasdaq fell sharply on news that while the Fed will pause rates for now, higher rates are possible. Higher bond yields and the risk of another rate hike this year caused a sell-off in equities and bonds. Oil saw profit-taking. The dollar index rallied on hopes that US rates will rise further.

Bottom line: risk-off.
 

Today’s Major News

Fed rate hike pause might not be the peak

The Federal Reserve paused rate hikes, keeping the benchmark rate at 5.25-5.50%, after 11 rate increases to a 22-year high. So much for the good news. Why did the market react so negatively? The Fed communicated that another rate hike is likely this year, with only two quarter-point cuts and not four in 2024. Twelve members of the FOMC saw another rate hike this year, while seven members wanted to keep rates unchanged. The Fed signaled that it intends to wait for more data to understand how previous rate hikes are affecting the US economy.

Summarizing guidance from Fed Chair Jerome Powell:

• He is waiting for more certainty that inflation is returning to target levels before lowering interest rates: “We want to see convincing evidence, really, that we have reached the appropriate level,” Powell said. “We've seen progress, and we welcome that – but you know, we need to see more progress before we would be willing to reach that conclusion”
• The FOMC is prepared to raise rates further “if appropriate,” Powell said. Officials have penciled in another rate hike before the end of the year, and just two rate cuts in 2024
• While Powell believes that an economic soft landing was a “plausible outcome,” it isn’t guaranteed and he isn’t willing to sacrifice the lower inflation target to achieve it
• The main reason why rates might have further to go is stronger economic activity and rapid growth in consumer spending, Powell said, rather than persistent inflation. “Broadly, stronger economic activity means we have to do more with rates,” he said
   

Risk of higher bond yields to slowing economic growth

Treasury yields spiked higher on the Fed announcement, with yields on 10-year Treasuries setting fresh 16-year highs at 4.35%, and 2-years moving up to 5.10%. Aside from the risks to equity market valuations, which we have discussed here, debt service costs are a fundamental economic concern.

The increased supply of debt certificates creates a need to increase demand for them at a time when the previous major buyers are reducing their ownership. The primary way to bring supply and demand into balance is to increase the yields on those debt certificates, leading to higher interest rates. This is another way that Congressional spending leads to increased interest rates, providing a drag to the economy, while contributing to inflation.

The Federal Reserve is decreasing its demand for those debt certificates by $1.14 trillion per year as it shrinks its balance sheet to reduce the monetary stimulus injected during the pandemic. Japan and China are the largest foreign holders of US debt certificates, and they are also both reducing their demand.

• China cut its ownership of US debt certificates by another $13.6 billion in July in the latest data available, bringing its current holdings to 14-year lows after offloading $191.4 billion over the previous 16 months
• Japan reduced its holdings of US debt certificates by $116.5 billion during the same period.
   

Today’s Major Markets
 

Equity markets fall after Fed rate news

• Equity markets fell despite the Fed not hiking rates, with the Nasdaq and S&P 500 off 1.3% and 0.8%, while the Russell 2000 fell 0.3%
• Foreign markets were weaker overnight, with the FTSE 100 and DAX up 1.0% and 0.7%, respectively, while the Nikkei 225 was down 0.7%
• The VIX, Wall Street’s fear index, spiked up to 14.4
   

Record high bond yields

• 2-year and 10-year bonds rose sharply to 5.10% and 4.35% respectively
• The dollar index reversed earlier weakness, rallying back to an unchanged position on the day at 105.2
• Versus the dollar, the Yen and Sterling both fell 0.2%, while the Euro was up 0.1%
   

Oil sees profit-taking

• Crude oil prices were off 1.0% at $90.3 per barrel
• Spot gold and silver prices were up by 0.1% and 0.7%, respectively, to $1,956 per ounce and $23.6 per ounce
• Grain and oilseed sector is mixed to higher
• Wheat prices are mostly weaker as they continue chopping sideways trying to form yet another bottom on the charts
• Corn and soybean prices are modestly higher on follow-through strength following USDA's lower crop ratings on Monday

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