How Fed's Powell caught markets 'off guard,' extending stock selloff as Treasury yields soar

Financial markets were absorbing the realization of how high Federal Reserve policy makers are willing to push interest rates, even if the issue of how long borrowing costs might stay there is unclear — causing stocks to finish lower for a fourth straight session, Treasury yields to soar, and the dollar to creep up on Thursday.

The rapid recalibration of expectations was evident across assets a day after the Fed’s policy decision on Wednesday. The Dow Jones Industrial Average DJIA, -0.46% and S&P 500 extended losses, while the policy-sensitive 2-year rate finished the New York session at a fresh 15-year high of 4.7% — turning the Treasury curve more negative in a deeply worrisome signal of an approaching recession. And the ICE U.S. Dollar Index DXY, -0.22% rose 1.4% to 112.

“The last set of Fed projections pegged the terminal rate at 4.75%. If the Fed has to push rates to 5% or higher, and has to keep them there for longer, then yields across the Treasury curve will have to adjust as well,” Pzegeo said in an email. “Markets are pushing their estimate for the terminal rate up to 5.25%, but they still have to address the Chairman’s ‘third phase’: How long do rates need to be restrictive? This could lead to higher rates further out the yield curve.

In the week leading up to the Fed’s policy announcement on Wednesday, financial markets had been trading on renewed hopes of a so-called Fed pivot, or shift away from aggressive rate hikes, but policy makers upset the proverbial apple cart. “The Fed’s decision and latest guidance are consistent with our recent view that it is too early to position for a dovish pivot in monetary policy,” said Mark Haefele, chief investment officer at UBS Global Wealth Management, and others.

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