As major indexes plunge into bear market territory, a growing number of experts are warning that key indicators suggest the latest stock selloff will only intensify before it subsides, especially if prolonged inflation keeps pushing the Federal Reserve to raise interest rates more aggressively.
After stocks cratered Monday, yields on two-year Treasurys rose as high as 3.42% overnight to briefly eclipse those for 10-year Treasurys—signaling bond-market investors are more bearish about the short-term economic outlook than the near-term, and creating a temporary yield-curve inversion that’s commonly viewed as a leading recession indicator.
Stubbornly high inflation and “growing fears” that the Fed’s looming interest rate hikes will spur a recession by undercutting economic growth are the “driving forces” behind the bearish bond trading, analyst Tom Essaye of the Sevens Report told clients in a Tuesday note, positing “the carnage in stocks will very likely continue” until the bond market stabilizes.
Despite all major indexes closing in bear-market territory on Monday, the CBOE Volatility Index, a measure of expected volatility known as the “fear gauge,” failed to hit levels that are consistent with market lows, Datatrek analysts said in an overnight email, noting markets tend to bottom only after periods of panic selling characterized by high Vix readings.
The Vix jumped to 34 points in Monday trading, falling short of this year’s high of 36.5 in March, and well below a reading of 66 on March 20, 2020—the day the S&P 500 tumbled to its lowest level of the Covid-induced market crash.
The market’s actual volatility lately has been “quite a bit higher than the volatility” implied by the Vix, but any spike to 40 or above could indicate the market has temporarily bottomed, says Ally Market’s Brian Overby.
In the meantime, Morgan Stanley’s Michael Wilson forecasts the S&P could plunge as low as 3,400 points this year given the mounting evidence of slowing growth and heightened earnings risk—representing nearly 9% downside from current levels.
The economy quickly and forcefully bounced back after the Covid recession in 2020, but the Fed’s withdrawal of pandemic stimulus measures this year has hit stocks and sparked renewed fears of a recession. After climbing nearly 27% last year, the S&P is down 22% this year, and the tech-heavy Nasdaq has plummeted 31%. “The Fed’s job gets more challenging by the day with inflation at a new 40-year high, coupled with a broader weakening of the economy,” says Danielle DiMartino Booth, the CEO and chief strategist of Quill Intelligence, cautioning the central bank is “flirting with an accident waiting to happen.”
What To Watch For
After the Labor Department last week reported inflation unexpectedly hit a 40-year high in May, officials are reportedly considering hiking rates by 75 basis points for the first time since 1994—higher than the 50-basis-point hike largely expected. The Fed is slated to unveil that decision Wednesday afternoon.
In another “very concerning sign” for investors, the dollar has posted “remarkable” strength over the past two days against currencies such as the yen and the euro, Datatrek’s Nicholas Colas and Jessica Rabe said Tuesday, noting unstable foreign-exchange markets have been a common feature of every significant global market dislocation since 1970.