Rate Hike Fears Spark ‘Spec Tech Wreck’ with Non Farm Payrolls on Tap

The fallout from the release of the minutes of the Fed’s 14-15 December meeting has been brutal for the markets, as participants now await today’s US non farm payrolls (NFP) data before making their next move.

Bonds are selling off, with yields rising while the riskiest most highly valued stocks in the equity markets are being offloaded in a dramatic rotation into industrials, financials and other cyclicals that will benefit from the economic upturn.

The content of the minutes surprised on the hawkish side.

Fed minutes spark rotation out of tech

Back in December, Fed Chair Jerome Powell indicated that the FOMC consensus was to “expect a gradual pace of policy firming”. He explicitly stated that policymakers did not anticipate raising rates before ending the taper process, but could hike before reaching full employment.

However, key parts of the minutes were taken as being out of step with Powell’s assertions, or at any rate the market’s previous interpretation of those remarks

“Participants generally noted that, given their individual outlooks for the economy, the labor market, and inflation, it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated,” according to the published minutes.

“Some participants also noted that it could be appropriate to begin to reduce the size of the Federal Reserve’s balance sheet relatively soon after beginning to raise the federal funds rate,” the minutes noted.

When the minutes were released on Wednesday the US equity markets immediately extended their losses and the market has been trading lower since then.

In what has been labelled a ‘spec tech wreck’, previously high-flying tech stocks have been particularly badly hit.

Higher interest rates undermines the stock prices of currently non-profitable tech companies whose valuations are based on future earnings expectations.

Non-farm payrolls figures out today are expected to show a rise of 447,000 in new jobs with an unemployment rate of 4.1%. Nasdaq 100 futures were in the red but have turned higher at the time of writing, up 0.2%.

If you are looking for the best companies to invest in, check out our guide. This could be the time to shift investment portfolios towards more of a value orientation, with a focus on cash-generative firms with consistently good dividend yields.

FOMC signals March liftoff in Fed Funds Rate

At December’s meeting the FOMC said it would be speeding up tapering of asset purchases, expecting to end the process in March as opposed to June as previously indicated.

In the light of the minutes market participants are firming around the view that March could see the beginning of the lift off in interest rates.

Fed presidents appeared to confirm that view in speeches made on Thursday. St. Louis Fed President James Bullard, considered to be one of the more hawkish policy makers, said the Fed could raise as soon as March.

With inflation running hot at 6.8% and the labour market tightening, the Fed in common with other central banks in the advanced economies, is in danger of falling behind the curve on controlling inflation.

If inflation expectations become embedded in the economy, then there is a danger that both companies and workers build those expectations into pricing forecasts and wage demands, setting up a self-fulling spiral.

Also, the supply chain bottlenecks that have contributed to the build up of inflationary pressures due to the shortages it has created, is likely to continue in the wake of the Omicron variant of the Covid virus.

Fed balance sheet rundown coming sooner too

In addition to the tapering and rates liftoff timings, analysts think that the Fed could move aggressively to start running down its balance sheet after years of asset purchases.

San Francisco Fed President Mary Daly said on Thursday that the rundown in the Fed balance sheet would come after the “normalisation” of the Fed funds rate.

All told, the impact of the monetary tightening by the Fed will be to suck liquidity out of the system, although policymakers will be wary of a policy misstep that overdoes the adjustment by threatening to derail the economic recovery and the goal of full employment.

A US non-farm payrolls figure that beats to the upside will likely be seen as adding grist to the mill for the Fed’s most hawkish FOMC members.