U.S. Treasury yields soared on Wednesday, and North American stock markets fell sharply, after minutes of the last Federal Reserve policy meeting came in more hawkish than expected, flagging three or more interest hikes this year to quell surging inflation. Tech stocks, which are extra sensitive to rising interest rates, were particularly hard hit, with the Nasdaq losing more than 3% and Shopify losing its crown to Royal Bank as most valued Canadian listing.
U.S. 2-year and 5-year yields, which mirror rate hike expectations and move opposite to bond prices, climbed to their highest since March and February 2020, respectively. The benchmark U.S. 10-year yield rose to its strongest level since April 2021. Canadian bond yields also rose, with the closely watched 5-year term rising to its highest level since early December.
In its minutes of the December meeting, the Fed said it might need to raise interest rates sooner than expected but also reduce its overall asset holdings to tame high inflation.
The minutes also showed some participants noted that it could be appropriate to begin reducing the size of the Fed’s balance relatively soon after beginning to raise the federal funds rate.
“This is news. This is more hawkish than expected. This shift towards hawkishness could be problematic for both stock and bond markets. Markets could struggle with this new shift,” said David Carter, chief investment officer at Lenox Wealth Advisors in New York.
“Indications that the Fed is very concerned about inflation could quickly create a view that the Fed will aggressively tighten in 2022,” he added.
Futures on the federal funds rate on Wednesday have priced in a roughly 80% chance of a quarter-percentage-point rate increase by the Fed at the March meeting following the release of the minutes.
Rate futures are also implying about three Fed hikes in 2022.
In afternoon trading, the U.S. 10-year yield rose to 1.712%, the highest since early April 2020. The Canadian 10-year bond was yielding 1.65%.
The S&P 500 fell more than 1%, its biggest daily percentage decline since Nov. 26, the first day of trading after news of the Omicron variant of the coronavirus.
The S&P 500 and Nasdaq quickly extended their declines after the release of the minutes. The Dow, which hit a record high earlier in the day, reversed course and ended down more than 1%. The TSX also gave up all its early gains, and closed with a loss of 0.93%.
The selloff was broad in the U.S., with all S&P sectors ending in the red, and Wall Street’s fear gauge, the Cboe Volatility index , closing at its highest level since Dec. 21.
The S&P 500 technology sector fell 3.1% and was the biggest drag on the benchmark index, while the rate-sensitive real estate sector dropped 3.2% in its biggest daily percentage decline since Jan. 4, 2021.
The Dow Jones Industrial Average fell 392.54 points, or 1.07%, to 36,407.11, the S&P 500 lost 92.96 points, or 1.94%, to 4,700.58 and the Nasdaq Composite dropped 522.54 points, or 3.34%, to 15,100.17.
Rising interest rates increase borrowing costs for businesses and consumers, and higher rates can depress stock multiples, especially for technology and other growth stocks.
Growth shares have been under pressure from a recent rise in U.S. Treasury yields.
The Russell 2000 index also suffered its biggest one-day drop since Nov. 26, while the S&P 500 financials index fell 1.3%, a day after it registered an all-time closing high.
Policymakers in December agreed to hasten the end of their pandemic-era program of bond purchases, and issued forecasts anticipating three quarter-percentage-point rate increases during 2022. The Fed’s benchmark overnight interest rate is currently set near zero.
Early in the day, an ADP National Employment report showed private U.S. payrolls increased by 807,000 jobs last month, more than double of what economists polled by Reuters had forecast.
The report comes ahead of the Labor Department’s more comprehensive and closely watched nonfarm payrolls data for December on Friday.
While most sectors were lower in Toronto as well, energy managed to end with a 0.49% gain and telco rose 0.25%. The Toronto Stock Exchange’s S&P/TSX composite index ended down 196.86 points at 21,039.66, its lowest closing level since Dec. 21. U.S. crude oil futures were 1.1% higher at US$77.85 a barrel, lending support to energy names.
Shopify’s shares fell by 13.4 per cent over the first two trading days of the year, losing another 2.5 per cent Wednesday as the sector lost 3.7 per cent with shares of Docebo Inc. losing 12.7 per cent and Hut 8 Mining Corp. off 12.6 per cent.
Shopify became the most valuable company by market capitalization in May 2020 and only briefly switched positions with Royal last March. RBC shares on Wednesday rose 1.08%, giving it a market cap of $197-billion versus Shopify’s $190-billion.
The Toronto market gained 22% in 2021, its best yearly performance since 2009, supported by massive stimulus, vaccine rollouts and hopes of a global economic recovery.
Robert Kavcic, senior economist with BMO Capital Markets, noted that even with the recent strong run in Canadian stocks, they are still lagging behind U.S. equities. That doesn’t necessarily mean they’re cheap, he cautioned, given that the sector composition is less growth oriented in Canada and the TSX typically underperforms with only a few exceptions, such as during commodity booms.
But even so, he thinks Canadian stocks have underperformed more than fundamentals suggest. On a relative basis, the TSX index is probing lows not seen since the late 1990s, he says. And the recent underperformance is not because of a lack of earnings. “In fact, the forward price-to-earnings on the TSX is roughly where it was pre-COVID, even as the S&P multiple has expanded by about 4 points. If valuations concern you, the TSX isn’t a bad-looking hiding place,” Mr. Kavcic said in a note Wednesday.
On Wall Street, declining issues outnumbered advancing ones on the NYSE by a 4.32-to-1 ratio; on Nasdaq, a 4.22-to-1 ratio favored decliners. The S&P 500 posted 59 new 52-week highs and 1 new lows; the Nasdaq Composite recorded 81 new highs and 307 new lows. Volume on U.S. exchanges was 12.18 billion shares, compared with the 10.4 billion average for the full session over the last 20 trading days.
With files from Reuters and The Canadian Press
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