Technology stocks, consumer goods and small caps faced the steepest downturns after the Federal Reserve dialed back on expectations for interest rate cuts in early 2024.
U.S. equity markets closed sharply lower on Wednesday, following the Fed’s message to markets: don’t expect a rate cut in March.
Although stocks were making something of a recovery on Thursday, on Wednesday the S&P 500 shed 1.6%, the tech-heavy Nasdaq lost 2.2% and the Russell 2000 index of small cap stocks fell 2.5%.
Looking at the highly-popular exchange traded funds that mirror the performances of these indexes, and it was the same story: the SPDR S&P 500 ETF SPY fell 1.6%, the Invesco QQQ Trust QQQ lost 2% and the iShares Russell 2000 ETF IWM shed 2.5%.
On Thursday, most indicators, including those from rate and money markets, suggested a decreased likelihood of an interest rate cut in March.
These also included the CME Group’s FedWatch Tool, which showed the probability of a quarter-point rate cut at the Fed’s March meeting is 44.5%, down from 52.8% on Wednesday before the Fed meeting, and down from 73.4% a month ago.
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March Rate Cut Not Likely
The Fed said a March rate cut was not likely, which poured cold water on the market expectations that drove the powerful fourth-quarter rally.
While this was only a slightly hawkish turn, analysts at Datatrek said the reaction suggests that markets believe the Fed got this call wrong.
Datatrek said: “Given that futures actually increased the odds of rate cuts this year, despite Powell’s comments and U.S. equities sold off by over 1.5%, it seems clear that markets believe the Fed is about to make a policy mistake.”
James Knightley, chief international economist at ING, said the Fed’s delay was because it was afraid of making a policy misstep.
“We suspect that the Fed recognizes its credibility was damaged by its ‘inflation is transitory’ assertion in 2021 only to have to rapidly reverse course with significant rate hikes through 2022 and 2023,” he said.
“The last thing the Fed wants to do is get it wrong again at a key turning point, loosen too soon, too quickly and reignite inflation pressures,” Knightley added.
Vulnerable Stocks
Nevertheless, the delay will mean that costs of borrowing remain higher for longer — hurting those companies with high levels of capital market borrowing, such as the big tech stocks, and those that rely on borrowing from more traditional sources of credit, particularly small companies.
Such was the market reaction on Wednesday to the Fed’s delay, that all the major techs were lower. Alphabet GOOGL shares fell 7.5%, as investors were left wanting more from its fourth-quarter results.
The iShares U.S. Technology ETF IYW fell 2.5% on Wednesday, but was rallying by around 0.8% in morning trade on Thursday.
Consumer discretionary stocks were also lower. After the series of rate hikes in 2022 and 2023, consumer credit is now becoming stretched, and market analysts fear a consumer slowdown is in the making.
Lululemon Athletica LULU fell 5.7%, while Nike NKE shed 3.2%. The Consumer Discretionary Select Sector SPDR Fund XLY, an ETF in which both Lululemon and Nike appear, fell 1.8% on Wednesday, but recovered 0.7% on Thursday.
Real estate stocks were also lower on fears that mortgage rates will move higher as interest rate cuts are delayed. Boston Properties BXP shed 5%.
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