As expected, the Dow snapped a four-week win streak on Friday, as investors paused their bullish bets on stocks amid fears that Federal Reserve Chairman Jerome Powell could push back against the idea of a dovish pivot at his Bankers Fest at Jackson Hole next week.
It was a decisive pivot that snapped the longest weekly rally since November, as short-sellers resurfaced and investors turned cautious after Federal Reserve officials beat the drum on hiking rates. Treasury yields climbed, while the dollar capped its best week since April 2020.
As a result, the S&P 500 Index notched its biggest daily decline since June, sending the benchmark to its first weekly loss in five weeks. The tech-heavy Nasdaq 100 under-performed major benchmarks, with growth-related stocks among the hardest hit Friday. Meanwhile, Wall Street’s fear gauge, the Cboe Volatility Index, jumped the most in more than two weeks, back above 20.
Note though that the expiration of $2 trillion in options, obliging investors to either roll over existing positions or start new ones, set the stage for a volatile session as failure to break a key threshold for the S&P 500 around 4,300 appeared to open the door to selling positions. And bears pounced. A basket of the most-shorted stocks dropped more than 6%, extending its weekly loss to 12% and giving short sellers their best week since March 2020.
Against a backdrop of fear and volatility, the dollar marched higher for a third day in a row. Treasuries fell, with the two-year Treasury yield, the most sensitive to policy changes, jumping 4 basis points.
Ahead of the Fed’s Jackson Hole gathering next week, officials reiterated their resolve to raise rates to curb stubbornly high inflation. Fed officials have made clear that they need to see clear and convincing evidence that price pressures are subsiding before slowing or suspending rate increases.
Minutes released Wednesday from the Fed’s July 26-27 board meeting reiterated that sentiment, noting inflation remains “unacceptably high.”
Taking that into account, the U.S. central bank has all the ammunition it needs to continue raising interest rates until it sees CPI coming back down to its 2% target. In that case, the truth is the markets are set a fall and the battle for inflation dominance will likely run for much longer than the markets have been expecting – we truly are now entering the Twilight Zone.
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