Stocks See Biggest Drop Since June as Rate-Hike Fears Grip Wall Street

U.S. equity markets saw their biggest selloff since June 24 on Friday after comments from a voting member of the Federal Reserve’s policy-setting committee suggested a September rate hike was still a possibility.

The Dow Jones Industrial Average dropped 394 points, or 2.13% to 18085. The S&P 500 shed 53 points, or 2.45% to 2127, while the Nasdaq Composite erased 133 points, or 2.54% to 5125.

All 10 S&P 500 sectors were washed in red Friday as utilities, telecom, and materials saw the biggest declines.

After the European Central Bank on Thursday opted to keep rates on hold and signaled it would not extend is bond-buying program past March 2017, a speech from Boston Federal Reserve President Eric Rosengren sparked renewed rate-hike concerns on Wall Street. Rosengren said there’s a “reasonable case” for raising rates later this month at the FOMC’s September 20, 21 meeting.  Despite headwinds from overseas, he cited a growing risk of both the U.S. economy and financial markets overheating should rates remain near historic lows.

Rosengren’s comments come after those of other Fed officials this month. Earlier this week on Wednesday, Richmond Fed President Jeffrey Lacker said the case for a rate hike is “strong” heading into the September meeting and that he doesn’t “see what will hold us back.”  Last month, New York Fed President William Dudley told FOX Business Network’s Peter Barnes the central bank is “edging closer to the point in time when it will be appropriate to raise rates further.”

Wall Street’s sharp move lower was in stark contrast to recent market action. As of Thursday, the S&P had gone 43 days without a 1% move in either direction, marking the longest streak of sub 10% moves in more than two years. Further, the CBOE’s VIX index, a closely-watched gauge of investor anxiety, jumped more than 34%, the biggest spike since the June 24, the day after Britain’s Brexit referendum.

While the market’s interest in Rosengren’s comments is certainly one of the driving forces behind the wave of negative sentiment, Russell Investments’ multi-asset investment strategist Paul Eitelman said his comments are still in contrast to Fed Chief Janet Yellen’s views, and contends recent data including a weaker-than-expected August non-farm payrolls report and ISM services and manufacturing figures don’t support a case the economy is growing at a robust pace.

“[Rosengren is] worried about asset bubbles, Yellen is much more worried about global risks and she’s taken cautious risks. Rosengren could be trying to convince Yellen to raise rates, it’s unclear how convincing he was today…we think the Fed will wait until December [to hike rates],” he said.

Indeed, odds of a September rate hike remain low on Wall Street. Fed funds futures, a measure of market expectations for changes in monetary policy, showed a 24% chance of a rate rise this month, with odds at 58.4% by the end of the year.

Economists at UBS explained that while recent remarks from Fed officials may signal a shift in thinking at the central bank, December is still its base case for the timing of the next rate hike.

“We have been down this path of setting the stage for a hike only to see a late shift in response to tepid data. Given the relative weakness in the ISM data and some slowing in bank lending, it would seem unlikely the Fed would feel that they could move forward into weakness,” the UBS Americas economics team wrote in a research note.

Adding to the market’s unease Friday was the announcement Fed Governor Lael Brainard, who traditiaonlly leans more dovish, will deliver a speech Monday at the Chicago Council on Global Affairs. It’s the last scheduled speech by a central bank member before the quiet period ahead of the FOMC meeting later this month. Eitelman said if Brainard’s remarks are similar in nature to Rosengren's, Wall Street could be in for another bloodbath session on Monday.

“If [the Fed] wants to move, I would expect her to sound more hawkish…it’s unlikely she’ll do that, but that’s the form they’d have to step. If she’s hawkish Monday that sends a pretty strong cue the Fed is seriously considering a September rate hike,” he said.

As stocks dropped, investors also dumped safe-haven government debt. The yield on the benchmark 10-year U.S. Treasury bond rose 0.062 percentage point to 1.675 – the highest since just before the U.K. voted to exit the European Union earlier this summer.  Yields move in the opposite direction of prices.

Other assets also experienced sharp declines Friday.  Global oil prices, after rallying Thursday, dropped more than 3% Friday to trade just above $45 a barrel. Gold prices also traded lower, shedding more than 0.6% to trade around $1,332.