Futures in the United States and in Europe are trading sharply lower as investors try to get their heads around another hawkish surprise that the Federal Reserve presented to the markets in their FOMC minutes released yesterday. As per the minutes, the Fed is considering reducing its exposure to bonds after it initiates raising its interest rates, which is expected to start as soon as March. Stock markets reacted negatively to the news, with the Dow Jones Industrial Average shedding nearly 392 points. As expected, stock market indices are likely to experience a rise in volatility for at least the first six months of 2022, as liquidity-addicted investors adjust to a relatively less easy monetary policy.
In Wednesday’s session, the Dow Jones Industrial Average fell 1.07%, while the S&P 500 index slumped 1.94%. The Nasdaq, the tech-savvy index, dropped 3.34%, while the Russell 2000 dipped 3.30%.
The most important event for the day is the unemployment claims data to be released by the Department of Labor, which will provide stock traders with an idea of whether the American labour market is improving, as it is an important factor considered by the Fed while deciding on its future monetary policy. In addition to this, the services Purchasing Managers’ Index (PMI) published by the Institute for Supply Management is also set to be released today.
The cryptocurrency markets also got tangled up in yesterday’s massive slump in equity markets. Bitcoin’s price is crashing and traders are wondering how low the price will go. The Fed’s stance to decrease liquidity in the American economy is a negative for risky assets. Last year, due to the ultra-easy monetary policies adopted by the Fed, Bitcoin, the benchmark for digital coins, surged to new highs. However, yesterday’s drop in investor sentiment dragged down Bitcoin’s price as low as $42,505.
Having said that, cryptocurrencies are supported by strong fundamentals and hence any drop in crypto prices should only be considered as an opportunity to bag some bargains. Moreover, moving onwards, investors can also benefit from increased volatility by using derivative to earn profits.
Investors should note that the biggest factor behind yesterday’s massive sell off and today’s risk off mode is that the Fed is likely to cut down its holdings of Treasuries and mortgage-backed securities, worth about $8.3 trillion, off its balance sheet. The FOMC minutes indicated that it could begin as soon as the beginning of the second quarter of 2022, after the Fed executes its first interest rate hike. This news came as a surprise to investors because the Fed has already sped up its winding down of quantitative easing measures and brought forward its timeline for raising interest rates. The discussion of Fed officials regarding reducing treasuries would further withdraw liquidity from markets and add to uncertainty related to the performance of financial markets in coming months.
Furthermore, the Nasdaq, the tech index, was the worst performer among the major indices, dropping more than 500 points as treasury yields continued their climb. This is because rising treasury yields and interest rates reduce the valuations of technology companies, which are relatively more dependent on future cash flows and high growth rates.
The rise in volatility in stock markets, this year, was already expected with the Fed sucking out liquidity from the economy to control the unprecedented rise in inflation. Moreover, according to Fed officials the American labour market is close to full employment levels and so this is the optimal time to shift away from an expansionary monetary policy. Furthermore, with coronavirus cases from the new strain rising and companies still facing supply chain issues, investors should be closely looking at earnings guidance by companies and economic reports to project how the American economy is likely to perform over the next few months.
After yesterday’s hawkish FOMC minutes report, the U.S. dollar appreciated against other major currencies as it is considered a safe haven asset and investors prefer to hold more U.S. dollars in times of uncertainty. Furthermore, rising treasury yields and sooner than anticipated interest rate hikes have also supported the jump in the U.S. dollar. On the other hand, riskier currencies such as the pound and euro took a beating.
Asian Pacific Markets
Asian Pacific stock market indices are moving downhill after Evergrande Group’s share price dipped nearly 0.63% after a report came out stating that the debt-dominated real estate developer will request a six-month extension to fulfil payments on an onshore bond. In addition to this, Tencent’s decision to get rid of its exposure to an online gaming business sparked concerns that other companies may also follow in Tencent’s footsteps as a result of China’s regulatory crackdown on the sector. As of 11.55 p.m. EST, the Nikkei dipped 2.72% and the Shanghai index dropped 0.16%. The Hang Seng index, in Hong Kong, fell 0.36%. The ASX 200 index slumped 2.94%, and the Seoul Kospi declined 0.81%.