US stocks sink over prospect of extended higher interest rates

Global equities sold off on Tuesday as investors braced for a prolonged period of high interest rates, while the dollar jumped to a 10-month high and Treasuries sold off.

Wall Street’s benchmark S&P 500 closed 1.5 per cent lower, while the tech-focused Nasdaq Composite dropped 1.6 per cent, both hitting their lowest levels since early June.

The latest decline for stocks comes as investors have raised their expectations that the Federal Reserve will keep interest rates higher for longer. While traders are mixed on whether the US central bank will raise interest rates by an additional quarter-point in this policy tightening cycle, bets on rate cuts in the coming year have dropped.

The shift comes after the Fed last week released its latest “dot plot” of interest rate estimates, which showed that officials forecast a much slower path for rate cuts in 2024.

At the start of September traders were betting US interest rates would be 4.2 per cent by the end of 2024 — implying as many as five interest rate cuts. Now traders in the futures market are expecting rates to be 4.7 per cent by the end of 2024, implying three or four cuts.

Investors predict the Fed’s first rate cut to take place next June after the central bank last week signalled a reduction in the overall number of cuts in 2024 and 2025.

As those expectations have changed, government bond yields across the US and Europe surged in the past week, as hawkish central bank officials indicated borrowing costs would remain at elevated levels for longer than the market expected.

The yield on the benchmark 10-year US Treasury was about flat on the day at 4.55 per cent, near its highest level since 2007, while the yield on the 30-year note rose to a post-2011 high of 4.7 per cent.

The moves in equities and bonds were explained by “cuts are being priced out”, said Jack Ablin, chief investment officer at Cresset Capital. “Rates are not going to drop as much as we thought a few months ago.”

The reaction was not limited to US markets.

European equities extended losses into the fourth straight trading session, with the region-wide Stoxx Europe 600 falling 0.6 per cent, while Germany’s Dax declined 1 per cent to close at its lowest level since March.

The yield on the 10-year German Bunds, a regional benchmark in Europe, was up 0.01 at 2.8 per cent on Tuesday, remaining near its highest level since 2011.

The dollar, which tends to rise when investors expect tight monetary policy, added 0.2 per cent against a basket of six peer currencies, reaching its highest level since late 2022.

“We have long thought that the equity market has been too aggressive in pricing in rate cuts and strong economic growth,” said Mark Haefele, chief investment officer at UBS Global Wealth Management.

“But an imminent end to rate hikes and the prospect of weaker growth as rates are kept higher for longer support our preference for fixed income.”

Investors are turning their attention to preliminary inflation data for the eurozone due later this week, which is expected to show annual consumer prices in the bloc dropped to 4.5 per cent in September, down from 5.2 per cent in August.

Christine Lagarde, president of the European Central Bank, reiterated in a speech on Monday that rates in the eurozone would remain high for as long as necessary to bring inflation back to the 2 per cent target, even as activity begins to slow.

Last week, the ECB lifted its benchmark deposit rate by 0.25 percentage points to an all-time high of 4 per cent, in what was likely to be the last round of tightening scheduled for this cycle.