Bond yields climb as stocks struggle in Fed run-up

Treasury yields climbed and stocks fell ahead of the Federal Reserve decision, with traders betting rates will be higher for longer to prevent an inflation flare-up. Brent oil briefly topped $95 a barrel.

U.S. five- and 10-year yields hit the highest levels since 2007.

Most major groups in the S&P 500 dropped, but the gauge came well off session lows, led by gains in some megacaps like Apple and Tesla.

Online grocery delivery business Instacart surged in its Nasdaq debut.

Disney slid on plans to nearly double its theme-park spending to $60 billion over the next 10 years.

The loonie rose the most among its developed-market peers after hotter-than-estimated inflation data in Canada.

Fed Chair Jerome Powell and his colleagues are widely expected to hold rates steady Wednesday.

Still, supply shocks such as climbing oil prices present the central bank with a quandary as they simultaneously boost inflation and curb economic growth.

Surging energy costs played a role in tipping the U.S. into recession in the mid-1970s, as well as the early 1980s and 1990s.

“The risks for headline inflation to heat up over the next couple of months are rising and that should complicate what the Fed does,” said Ed Moya, senior market analyst for the Americas at Oanda.

“Do policymakers become convinced that despite a resilient labor market, pricing pressures will continue to ease? If core inflation shows it is struggling to continue to drop, the higher-for-longer rate regime will last a lot longer than the market is pricing in.”

In fact, after pricing in a “peak” in interest rates in November, trader bets have recently shifted out to December – suggesting that perhaps the market is giving credence to signals of a more pronounced central bank pause, according to Christopher Jacobson at Susquehanna International Group.

Investors are keenly focused on Fed officials’ updated quarterly rate projections – known as the dot plot – that will be released Wednesday at the conclusion of the policy meeting.

High on the watch list will be whether these forecasts continue to reveal a median view for one more quarter-point hike this year and whether forecasts for 2024 scale back the 100 basis points of rate reductions that officials foresaw in June.

To Fawad Razaqzada at City Index and FOREX.com, should the Fed revise the 2024 median plot to indicate fewer rate cuts than previously projected, that would discourage bearish bets on the dollar.

Since the Fed’s June forecasts, the disinflationary process has stabilized somewhat – but inflation risks are increasing, Lauren Goodwin at New York Life Investments said.

As a result, officials will likely keep the incremental quarter-point hike in their projections, she noted – adding that a final increase would possibly be delivered in November.

“Our Fed checklist suggests the bar for rate cuts is still high,” Goodwin said. “Unless we see a meaningful economic slowdown, inflation is likely to fall in a slow and nonlinear way. In other words, for the Fed to cut rates next summer – like the bond market has priced – we believe we’d need to see a recession.”

Data Tuesday showed new U.S. home construction dropped to the lowest level since June 2020 – highlighting the toll of declining housing affordability.

The sharp slide is concerning because housing has been one of the pillars of the economy that has held up much better than expected, said Chris Zaccarelli, chief investment officer for Independent Advisor Alliance.

“If it turns out that this is the first crack in an otherwise bulletproof consumer, then it could change the narrative from an economy that is impervious to rapid interest rate hikes to one that is vulnerable and susceptible to a recession,” he added.