Market Extra: Investors sell off bonds and stocks as chances grow for another half-point rate hike by Fed in September


Expectations are growing that the Federal Reserve will deliver another half-percentage point rate increase in September after similar moves in June and July, triggering broad-based selloffs in both bonds and stocks on Wednesday.

All three major U.S. stock indexes were down in the afternoon, while an aggressive selloff across Treasurys pushed yields on 2- through 7-year maturities up by 11 to 13 basis points each. Meanwhile, fed funds futures traders saw a 59% chance that the central bank’s main policy rate would get between 2.25% and 2.5% by September, which implies 50 basis point hikes at each of the Fed’s next three meetings. That’s up from 55% on Tuesday, according to the CME FedWatch Tool.

Read: Experts see little chance of Fed ‘pause’ in September

Investor sentiment has shifted back and forth between the Fed’s ability to contain inflation running near a four-decade high and the prospects of slowing U.S. growth. The hope that slower growth could prompt policy makers to pause rate increases, or deliver a smaller quarter-point hike, was a big reason why stocks rallied during the latter half of May as yields fell off. About a week ago, Atlanta Fed President Raphael Bostic told reporters that a pause in September might make sense and he has since elaborated on his view.

But in the past few days, investors have reassessed the Fed’s most likely path forward, boosted their expectations for where rates could end up, and even heard growing alarm within the central bank system: On Monday, Fed Gov. Christopher Waller said he supports hiking rates by 50-basis-point increments for several meetings until he sees signs of inflation coming down. Then, on Wednesday, San Francisco Fed President Mary Daly said in an interview with CNBC that the time to pause the rise in interest rates is when the Fed gets its benchmark policy rate up to about 2.5%. Meanwhile, St. Louis Fed President James Bullard said the Fed is “on the precipice of losing control of inflation expectations.”

“The roulette wheel spun again,” Neil Azous, chief investment officer of Rareview Capital, wrote in an email Wednesday. “A 50 bps interest rate hike in September is back to the `most likely’ outcome. Also, the terminal rate for the cycle is back up to 3.25% from 2.75%.” After a bounce in the S&P 500, which “included a significant short covering wave, risk assets are responding negatively to the move higher in interest rates,” Azous said.

Adding to pressures on stocks and bonds on Wednesday was the Bank of Canada’s statement that it is prepared to act more forcefully if needed to meet its 2% inflation target. The bank also raised its target on the overnight rate by 50 basis points for a second straight time, to 1.5%.

“The reality of the Bank of Canada coming out and saying it’s willing to be as forceful as needed could be another factor pressing yields higher here,” said Tom Porcelli, managing director and chief U.S. economist at RBC Capital.

“In terms of what’s happening here today, the market seems to be really searching for direction and is struggling to figure out what the next move is going to be by the Fed,” Porcelli said via phone. ”Fed officials seemingly come out on a daily basis —sometimes saying very different things — and there’s an element of market confusion.”

As of Wednesday afternoon, all three major stock indexes DJIA, -0.54% SPX, -0.75% COMP, -0.72% were lower, led by the S&P 500. An aggressive rise in 2- through 7-year Treasury yields shrunk spreads, in what’s typically seen as a worrisome sign about the outlook. Meanwhile, the 5-year real or inflation-adjusted yield was on the verge of turning positive, according to Tradeweb.

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