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Stocks sink after Fed chair points to higher rates to come

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US stocks sank on Wednesday after Federal Reserve chair Jay Powell cautioned that it was still “very premature” to think about pausing interest rate rises as the central bank delivered its fourth supersized increase in a row.

Wall Street’s benchmark S&P 500 index ended the day 2.5 per cent lower and the Nasdaq Composite fell 3.4 per cent after a volatile afternoon of trading as investors struggled to digest the Fed’s messaging.

Stocks initially jumped as policymakers appeared to hint they could soon slow the pace of future increases, but fell back as Powell spoke to journalists.

In a statement alongside the widely expected rate rise, the central bank said it expected to continue increasing rates but would “take into account . . . the lags with which monetary policy affects economic activity and inflation”.

Powell added during his conference that a slowdown in rate rises “may come as soon as the next meeting or the one after that”.

Markets have rallied in recent weeks on any signs that policymakers will rein in the pace of further rate rises.

However, Michael de Pass, head of linear rates trading at Citadel Securities, said: “What’s critical now is this real focus on the destination — a slower pace [of increases] doesn’t mean lower rates. Risk assets were thinking about today as a possible policy pivot which, given where core inflation is, seemed quite misplaced.”

Line chart of Performance on November 2, 2022 (%) showing US stocks slide as Fed's Powell signals tighter policy to come

The Fed has aggressively lifted rates this year in an attempt to tame stubbornly high inflation, but concerns have grown that the central bank will tighten policy too far and push the US and the global economy into a recession. Powell himself said that the path to a so-called soft landing had “narrowed”, and that “no one knows if there’s going to be a recession or not”.

“The new reference to monetary lags in the statement reflects the concern that . . . there is a real risk of overtightening and tipping the economy into a recession,” Luke Bartholomew, senior economist at Abrn, said. “The trick for the Fed is to acknowledge these concerns without giving markets permission to ease [conditions]. We continue to think that this balancing act will prove too difficult for the Fed to manage.”

Government bond prices also whipsawed after the Fed decision. The yield on the 10-year US Treasury note, which had dropped as low as 3.97 per cent, surged back to 4.09 per cent. Rising yields reflect lower prices. The two-year Treasury yield, which is particularly sensitive to monetary policy expectations, rose 0.06 percentage points to 4.60 per cent.

Line chart of Federal funds target rate (upper bound) % showing The Fed has sharply lifted borrowing costs this year

Earlier, Chinese equities rose, consolidating gains made in the previous session as unsubstantiated rumors that the country was seeking to end its strict zero-Covid policy boosted investor sentiment.

Hong Kong’s Hang Seng index was up 2.4 per cent, while China’s CSI 300 added 1.2 per cent. The two indices respectively closed 5.2 per cent and 3.6 per cent higher on Tuesday. Elsewhere in Asia, Japan’s Topix added 0.1 per cent. The regional Stoxx Europe 600 fell 0.3 per cent.