Traders Increase Fed-hike Bets After Hot ISM Data

Stocks experienced a decline while Treasury yields saw an uptick following robust data on the US services sector, fueling expectations that the Federal Reserve may maintain higher interest rates for an extended duration.

The S&P 500 extended its decline, breaching the 4,500 level, while the Nasdaq 100 witnessed a 1% dip, led by a selloff in major tech stocks such as Tesla Inc. and Nvidia Corp. In the bond market, two-year Treasury yields crossed the 5% mark. The US dollar edged higher, with its recent surge prompting both Japan and China to intensify their efforts to defend their respective currencies. Swaps contracts indicated a rising belief in a Fed rate hike in November, with a 60% probability. Additionally, three major US carriers cautioned about an unexpected surge in jet fuel prices during this quarter.

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The Institute for Supply Management's services index climbed to a six-month high in August, reaching 54.5. Readings exceeding 50 signify expansion, and this figure surpassed all estimates in a Bloomberg economist survey.

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Quincy Krosby, Chief Global Strategist at LPL Financial, commented, "The ISM Services Sector report underscores the resilience of the largest portion of the economy. Unfortunately, the prices-paid component moved in the wrong direction — similar to the higher prices paid in the manufacturing report — edging markedly higher. This is certainly not good news for a data-dependent Fed."

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Fed Bank of Boston President Susan Collins emphasized the need for patience among policymakers as they assess economic data to determine their next steps, indicating that further tightening may still be necessary. Meanwhile, former Fed Bank of St. Louis President James Bullard suggested that officials should continue to factor in an additional hike this year when updating their projections later in the month.

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Jeffrey Roach, Chief Economist at LPL Financial, identified two significant challenges for the Fed at this stage: the risk of entrenched inflation and the risk of a consumer slowdown when excess savings diminish. Roach anticipated that, given the data, the Fed would likely announce a hawkish pause at the next meeting, with the hard data not yet providing a compelling basis for strong views on subsequent meetings. He cautioned investors to prepare for potential market turbulence.

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Ben Jeffery at BMO Capital Markets pointed out that the ISM data was the only top-tier release of the week. After the dust settles, market attention is expected to return to the corporate-issuance calendar, which holds "bearish implications" for Treasuries.

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Henry McVey, CIO of KKR & Co., recommended that investors increase their exposure to real assets, anticipating stronger-than-expected US economic growth in 2023 while inflation remains elevated in 2024.

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The Canadian dollar edged lower as the Bank of Canada held interest rates steady but kept the possibility of additional hikes open. European shares saw a decline, particularly as German factory orders plunged. The pound weakened following comments by Bank of England Governor Andrew Bailey, who suggested that further rate hikes in the UK might not be necessary, citing a likely "marked" drop in inflation for the year and suggesting that monetary policy may have reached a peak in the current cycle.

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