US stock continue to stumble as traders rethink rates

Markets

US stocks grappled with uncertainty on Wednesday in the wake of a cautious string of commentary from the US Federal Reserve officials. The S&P 500 is currently experiencing its longest non-bullish streak in months. While this pullback may appear minor compared to the overall melt-up trend seen in 2024, it raises questions about whether it could mark the beginning of a larger shift in market sentiment.

Currently, we find ourselves approximately 5% below the recent market highs, signalling that we are halfway to meeting the criteria for an official correction. This observation underscores the significance of monitoring market movements and potential shifts in sentiment moving forward.

Investors have been quick to attribute recent market fluctuations to geopolitical tensions, particularly the heightened war risk premium and the looming threat of higher oil prices, disrupting the previously prevailing narrative of deflationary pressures.

However, it’s more probable that equities are perhaps just now adjusting to the recalibration of the Federal Reserve's less dovish monetary policy trajectory and broader interest rate dynamics. Indeed, over the past trading week, there has been a collective reassessment of the likelihood of Fed rate cuts amid thoughts of a higher terminal rate, effectively setting a much loftier implied floor for market discount rates, which serves as the foundation for the rest of the yield curve, and a less bullish springboard for stocks.

Oil prices fell precipitously overnight as tensions in the Middle East appeared to ease. Traders interpreted the weekend's events as an isolated incident rather than the start of a prolonged conflict; hence, war risk premiums evaporated. However, stock market operators remained indifferent to these deflationary developments.

Despite a slight retreat in bond yields on Wednesday, spurred by a well-received 20-year bond sale, yields have risen significantly since hitting lows in December. The 10-year yield, for instance, has surged by around 80 basis points off this year’s lows. Market expectations for rate cuts have also shifted drastically from what they were when yields were at their lowest. Indeed, the fed fund curve bears little resemblance to the levels that initiated the dramatic surge in stock markets earlier this year.

Oil Markets

As oil traders recalibrate their positions, shedding some of the war premium previously built into prices, they face another challenge: a Federal Reserve adamant about tackling inflation by maintaining elevated interest rates until price pressures subside and consumer spending moderates. This stance and apprehensions regarding near-term demand erosion amidst soaring gasoline prices, notably underscored by increased US oil inventories and tepid consumer data from China, outweighed concerns about a broader regional conflict in the Middle East. Consequently, oil prices plummeted by nearly 3%.

There's no denying that the Middle East remains a volatile region, akin to a powder keg resting atop smouldering embers. However, as of now, the situation hasn't escalated to the point of significantly disrupting regional oil production.