Nasdaq tumbles as Treasury yields rise on Fed rate hike expectations

What’s driving markets?

The S&P 500 and the Nasdaq Composite dipped Wednesday, after reaching the highest levels since 2022 in the previous session. The rally in technology stocks seems to fade after the Bank of Canada unexpectedly raised its benchmark interest rate by a quarter of a percentage point, resuming its monetary tightening after a four-month pause. 

On Tuesday, Australia’s central bank also defied expectations, delivering a second straight quarter-percentage-point interest-rate increase.

U.S. investors were worried a widely expected pause in the Federal Reserve interest-rate hiking cycle next week may risk a similar experience in the U.S., as the potential for resurgent inflation and stronger-than-expected consumer spending will provoke surprise rate hikes.

See: Bank of Canada surprise rate hike reminds U.S. investors ‘pause’ doesn’t mean ‘stop’

Traders were pricing in a 38% probability that the Federal Reserve will deliver another 25-basis point hike after its meeting on June 14, according to the CME FedWatch tool. That’s up from 21.8% one day ago. Fed officials have indicated that a pause is justified though, while emphasizing that skipping a rate increase in June doesn’t mean they can’t deliver a hike at a later date.

Andrew Hunter, deputy chief U.S. economist at Capital Economics said even though there appears to be enough support on the FOMC (Federal Open Market Committee) for a pause at next week’s meeting, the statement and new projections due out next Wednesday will make clear that “this is not the end of the hiking cycle.”

“We now expect rates to be raised again at the July meeting. And although we still think that falling inflation and weak GDP growth will convince the Fed to move to the sidelines soon, it is now likely to take until early next year for officials to be ready to start cutting again,” Hunter wrote in a Wednesday note.

Chances of a 25-basis-point hike which brings the policy rate to the 5.25%-5.50% range in July was priced at 50.5% Wednesday afternoon.

See: Treasury yields rise as investors cool their heels ahead of data

“I think there’s a realization among central banks but also investors that the cost of capital wasn’t yet at the tipping point. We’re not sending the world economy into recession,” said Phillip Colmar, partner and global strategist at MRB Partners.

“That means you price out the recession risk, and it’s not bad for equities. But the flip side of it is that [central banks’ tightening] policy may not be done,” said Colmar.

“So you got a better growth backdrop, but you got higher interest rates,” noted Colmar. It takes off some of the profits off of big tech companies, which have been leading stocks gains so far this year, but it “broadens the rally out”, Colmar said in a call.

However, the small-cap Russell 2000 index was up 1.6% on Wednesday, extending its rally that sent the index to its highest close since March 9 in the previous session. The index was also outperforming the Nasdaq Composite by 5.04 percentage points so far this month, its largest outperformance in the first five trading days of a month since October 2020, according to Dow Jones Market Data.

See: Small-cap stocks surge as broader U.S. market stalls. Here’s why.

Bill Hench, portfolio manager of the First Eagle Small Cap Opportunity Fund, said small-cap stocks, which have been lagging behind its large-cap peers, are “logical places” to look now.

“If suddenly people think we are not gonna get a recession, they start to look at sectors that hasn’t done a good part in the next two year,” Hench said.

Adding to the pressure on stocks was more gloom from China, where data showed exports fell 7.5% from a year ago in May, dropping from 8.5% growth seen in April, and much worse than the 1.0% decline seen from economists polled by The Wall Street Journal. A string of recent weak updates have heightened expectations that officials will soon make moves to stimulate the economy.

In U.S. economic data, the U.S. international trade deficit jumped 23% in April to a six-month high of $74.6 billion, reflecting an increase in imports such as cellphones and foreign autos. The trade gap rose from $60.6 billion in March. Larger deficits subtract from gross domestic product, the official scorecard for the economy.

Read: What if the S&P 500 fumbles its bear-market exit? What strategists think of the role of tech in this rally.

For the past few days, the S&P 500 has been on the verge of exiting its longest bear-market run since 1948. A close above 4,292.44 would mark a 20% rally off the bear-market closing low of 3,577.03 set on Oct. 12, 2022, according to Dow Jones Market Data. That would meet a widely used definition of the end of a bear market.

Companies in focus

• Netflix
  NFLX,
  +0.60%
  climbed 1.1% Wednesday after JPMorgan increased its price target on the stock of the streaming giant, citing the company’s effort to limit password sharing on its platform.

• Coinbase
  COIN,
  +2.38%
  was up 3.5% following a 12% selloff the day before after the SEC alleged the crypto exchange was operating as an unregistered exchange and broker. Ark’s Cathie Wood bought the dip in Coinbase.

• Ollie’s Bargain Outlet Holdings Inc. 
  OLLI,
  -3.55%
   stock dropped 4.3% after the closeout merchandise retailer boosted its fiscal 2024 outlook for adjusted profit to $2.56 a share to $2.65 a share, compared with the Wall Street analyst forecast of $2.56 a share.

• Campbell Soup Co.
  CPB,
  -7.38%
  stock plunged 7.2% Wednesday after it reported better-than-expected adjusted third-quarter earnings, while its revenue was about flat with Wall Street estimates. 

— Barbara Kollmeyer contributed.