The July 25-26 Federal Open Market Committee (FOMC) meeting minutes revealed that most Federal Reserve officials identified “significant” upside risks to inflation, which could require further rate hikes. Although upbeat data prompted the central bank to abandon its recession forecast, participants remained concerned that tightening financial conditions since the beginning of last year could have more substantial consequences than anticipated.

Policymakers hinted at the possibility of future interest rate increases to curb inflationary pressures, leading to a sell-off in stocks and a rise in Treasury yields. However, central bank officials were divided in regard to the necessity for additional rate hikes.

While the primary objective of the Federal Reserve to bring inflation down to its target of 2% remained unchanged, concerns among investors in regard to the course of interest rates persisted. While the central bank acknowledged the economy remains resilient and the labour market is still robust, it refrained from declaring victory over inflation.

The data-dependent stance of the Fed suggested that the upcoming September meeting remained pivotal, with the decision hinging on comprehensive data analysis. According to the FedWatch Tool the market sees just a 12% chance of a rate hike in September, and a 35% chance of a hike by November.

Source: TradingView

Equity markets have been under selling pressure this week amid data underscoring sticky inflation and a robust economy, which raises fears of interest rates staying elevated for longer, despite investors largely expecting the Fed’s monetary tightening to be near its end.

The sell-off in equities was partially triggered by the surge in Treasury yields which hints that rate hikes could return later this year. Concerns about China’s economic slowdown and widening housing crisis quashed appetite for risk and added to the selling pressure.

The rise in bond yields has the ability to dent the strong rally from the beginning of the year. Also, August and September are the seasonally weakest months of the year for equities, raising further concerns the pull back could extend deeper.

Overall, this week’s market correction accelerated after Wednesday’s publication of the Federal Reserve meeting minutes, which suggested officials are considering tighter policy, slamming hopes that the central bank was done raising rates. Investors are expecting Fed chair Jerome Powell to deliver similar remarks at the Jackson Hole symposium next week.

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