Market Volatility Intensifies: Rates, Recession Risks, Fed Guidance

Economic Headwinds: bond market turmoil, housing slowdown and yield curve inversion

• Rising interest rates and recession risk challenge markets; Powell's comments and government shutdown loom large.
• Bond market turbulence impacts mortgages and housing; yield curve inversion raises recession concerns.
• Individual stocks in spotlight: Microsoft's acquisition, Amazon's TV ads, and Instacart's IPO performance.

On Friday, the stock market hopes to reverse a three-day losing streak, but the challenges it faces are substantial. A combination of concerns, including the prospect of prolonged high interest rates and the looming risk of a government shutdown, has taken a toll on investor sentiment.

On Thursday, the S&P 500 experienced a 1.6% decline, with all 11 sectors ending the day in negative territory. Meanwhile, the Nasdaq Composite, which is heading towards its worst week since March, faced a 1.8% drop, marking a 3.5% decline since the previous Friday. Both the S&P 500 and Nasdaq Composite are now on track for their first consecutive monthly declines since September of the previous year, making this the worst month since December.

Why the market dropped

Several catalysts have contributed to this week's market sell-off. On Wednesday, despite leaving interest rates unchanged, Federal Reserve Chairman Jerome Powell conveyed the central bank's expectation of maintaining higher interest rates for an extended period, surpassing the expectations of most economists. According to the Chicago Mercantile Exchange (CME), there's a growing likelihood that rates will remain at their current levels until July of 2024.

Simultaneously, the increasing possibility of a government shutdown adds to the unease as lawmakers grapple with reaching agreements on both a continuing resolution and the budget for the upcoming fiscal year. Adding to these concerns is the ongoing United Auto Workers (UAW) strike, with threats of additional walk-offs expected today. Lastly, crude oil prices have surged back above $90 per barrel, reigniting concerns of rising inflation.

The impact hasn't been limited to stocks alone. Bond markets have also witnessed challenges, resulting in higher interest rates. The 30-year bond saw its rate rise to 4.55%, the highest level since 2011 and the most significant one-day increase since June of the previous year, according to The Wall Street Journal. Yields on the 10-year note reached their highest point since 2007, closing at 4.79%. Even the two-year note saw its rate climb to levels not observed since 2006, ending the day at 5.15%.

Impact on the mortgage market

The surge in interest rates is spilling over into the mortgage market, with the standard 30-year mortgage rate reaching 7.19%, marking the sixth consecutive week above 7%. Housing market data for August revealed a slowdown, with existing home sales totaling 4.04 million, falling short of the forecasted 4.10 million.

The persistent inversion of the yield curve continues to raise concerns about an impending recession. Campbell Harvey, a professor at Duke University, is widely credited with popularizing the relationship between yield curve inversions and economic downturns. Historically, using the 3-month and 10-year yields, an inverted yield curve has correctly predicted every recession dating back to 1968 without a single false positive. Harvey's analysis also suggests an average lag time of 13 months between the inversion and the onset of a recession. Given that the 3-month and 10-year yields inverted in late October of the previous year, we are approaching the 11-month mark, suggesting a recession may coincide with the upcoming holiday season.

Individual stocks

Individual stocks are seeing notable developments. The U.K.'s Competitions and Market Authority appears inclined to approve Microsoft's $75 billion acquisition of Activision Blizzard, (ATVI) prompting a nearly 2% premarket increase in Activision's shares. Amazon AMZN announced its intention to introduce commercials to its Prime TV content early next year, with an option for a commercial-free subscription at an additional cost of $2.99 per month.

McDonald's (MCD) is increasing the fee for new franchisees from 4% to 5%, affecting only new franchisees, not existing ones. The company's shares saw a premarket increase of just under 1%. On the other hand, Cisco (CSCO) faced a 4% decline on Thursday after revealing plans to acquire cybersecurity firm Splunk for $28 billion. Splunk's shares, in contrast, closed higher by 13%. Meanwhile, shares of Apple (AAPL) indicated a 1% increase as the new iPhone and Apple Watch hit the market today.

Lastly, recent IPO activity is worth noting. Both ARM Holdings (ARM) and Instacart went public this month, with differing outcomes. While ARM initially garnered enthusiasm, sending its stock as high as $69, it has since retraced, closing Thursday at $52.16, marking its lowest close since the IPO. Similarly, Instacart (CART) closed at $30.65 on Thursday, below its IPO price of $31. The lackluster performance of these offerings may have implications for future IPOs, potentially discouraging other companies from going public.

For today, stocks are indicating an opening in positive territory. Nevertheless, it's common in declining markets to witness a strong opening followed by subsequent weakness. Therefore, it's essential to observe how the market holds its gains as the day unfolds. As always, the prudent approach involves sticking to your investment plan and long-term objectives, remaining adaptable amid market fluctuations and uncertainties.

JJ Kinahan is CEO of IG North America—which includes tastylive, tastytrade and IG's FX Business. Kinahan traded for 21 years at the Chicago Board Options Exchange. He serves on the CBOE Advisory Board and the SIFMA Options Committee. @thejjkinahan

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