Wall Street slumps, erasing a big rally from a day earlier

Wall Street slumps, erasing a big rally from a day earlier thumbnail

Stocks closed sharply lower on Wall Street as worries grow in markets that the higher interest rates the Federal Reserve is using in its fight against inflation will derail the economy

May 5, 2022, 9: 07 PM

6 min read

NEW YORK — A sharp sell-off left the Dow Jones Industrial Average more than 1,000 points lower Thursday, wiping out the gains from Wall Street’s biggest rally in two years, as worries grow that the higher interest rates the Federal Reserve is using in its fight against inflation will derail the economy.

The benchmark S&P 500 fell 3.6%, marking its biggest loss in nearly two years, a day after it posted its biggest gain since May 2020. The Nasdaq slumped 5%, its worst drop since June 2020. The Dow and other indexes’ losses offset gains made a day earlier.

“Yesterday’s sharp rally was not rooted in reality and today’s dramatic selloff is a reversal of that misplaced exuberance,” said Ben Kirby, co-head of investments at Thornburg Investment Management.

Wall Street’s rapid day-to-day decline reflects investors’ uncertainty over the many threats facing the economy, including high inflation and the Federal Reserve’s attempt to control higher prices by raising interest rates.

The Federal Reserve announced Wednesday a half-percentage-point increase in its short term interest rate. This was widely anticipated. Stocks rebounded after the announcement, but then rose sharply as bond yields fell. Fed Chair Jerome Powell assured investors that the central bank was not considering changing to more aggressive, three quarters point rate hikes while the Fed continues to increase rates in the coming months.

But any relief Powell’s comments gave stock investors vanished on Thursday. Stocks fell and bond yields rose. The yield on the 10-year Treasury note rose to 3.04%. Rising yields are sure to put upward pressure on mortgage rates, which are already at their highest level since 2009.

Investors remain uneasy about about whether the Fed can do enough to tame inflation without tipping the economy, which is already showing signs of slowing, into a recession. Investors are also worried about rising interest rates and high inflation. They also have to worry about lingering supply chain disruptions, and geopolitical tensions. The biggest problem is that there are so many moving parts. The unanswered question is how much the Fed’s attempts to control inflation will result in economic slowing and possibly a recession,” stated Terry Sandven, chief equity strategist, U.S. Bank Wealth Management.

The S&P 500 fell 153. 30 points to 4,146. 87, while the Nasdaq slid 647. 16 points to 12,317.69. The Dow briefly skidded 1,375 points before closing down 1,063. 09 points, or 3.1%, to 32,997.97.

Smaller stock prices also dropped sharply. The Russell 2000 fell 78. 77 points, or 4%, to 1,871.15. Investors are worried about the Fed’s aggressive shift in raising interest rates. It is unsure if it can manage the delicate dance to slow down the economy enough to stop high inflation but not too much to cause a downturn. Powell stated Wednesday that there was a “good possibility” that the economy would have a “soft landing or outcome” as the central banking raises rates.

But Wall Street doesn’t always believe.

“Concerns focus on whether the Fed will have to become even more hawkish to bring demand down — and that would involve slowing the economy more than they now project,” said Quincy Krosby, chief equity strategist for LPL Financial. “And today’s market action is questioning whether ‘soft-ish’ is plausible.”

The latest move by the Fed to raise interest rates by a half-percentage point had been widely expected. Wall Street was worried that the Fed might raise rates by three-quarters to a percentage point at its next meeting, although markets were steady this week. Powell said that the central bank was “not actively considering” such a rise.

The central bank also announced it would begin reducing its $9 trillion balance sheet. It mainly consists of Treasury and mortgage bonds. This reduction will take effect from June 1. These large holdings are a policy tool used by the Fed to keep long-term interest rate low, such as those on mortgages. When Powell stated that the Fed was not considering a massive increase in short-term interest rates, it sent a signal for investors to send stock markets soaring and bond yields plummeting. A slower pace of interest rate hikes would reduce the risk of the economy going into recession and also lower prices for all types of investments.

But a decrease in the likelihood of a three quarters point hike does not mean that the Fed has stopped raising rates steadily, sharply, and fighting inflation. BNP Paribas economists still expect that the Fed will continue to raise the federal funds rate until it reaches 3.3% to 3.5%. 25%, up from zero to 0. 25% earlier this year.

“We do not think this was Chair Powell’s intention,” economists at BNP Paribas wrote in a report, citing the market’s jubilance on Wednesday, “and we reckon we could see coming ‘Fedspeak’ seek to re-tighten financial conditions.”

The Bank of England on Thursday raised its benchmark interest rate to the highest level in 13 years, its fourth rate hike since December as U.K. inflation runs at 30-year highs. Energy markets are still volatile due to the ongoing conflict in Ukraine and high demand amid tight oil supplies. European governments are looking at an embargo to replace Russian energy supplies. Thursday’s decision by OPEC and allied oil-producing nations was to increase crude oil flows to the rest of the world.

Investors have been worried about rising oil and gas prices as they attempt to predict how inflation will affect businesses, consumer activity, and overall economic growth.

Homebuilders fell broadly Thursday as average long-term home loan rates climbed. D.R. Horton fell 5.8%.

The average rate on a 30-year fixed-rate mortgage rose to 5. 27% this week, its highest level since 2009, according to mortgage buyer Freddie Mac. A year ago, it averaged 2.96%. Mortgage rates tend to follow moves in the 10-year Treasury yield. After years of rising home prices, the sharp rise in mortgage rates has made it difficult for homebuyers to afford their homes.

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AP Business Writer Stan Choe contributed. Veiga reported from Los Angeles.


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