US Federal Reserve’s rate hike shift sends stocks into disarray

European and US stocks pulled in different directions on Thursday as traders digested the Federal Reserve bringing forward its forecasts for hiking interest rates to prevent the US economy from overheating.

The dollar meanwhile hit two-month peaks versus the euro and yen, and the highest level against the pound for one month, on the prospect of higher borrowing costs.

After a mixed Asian session, European stocks spent much of the day down, but Paris and Frankfurt managed to the end the day with gains.

London, however, closed down 0.4 per cent.

“The FTSE100 is the worst performer largely as a consequence of underperformance in the basic resource sector where a stronger US dollar is weighing on commodity prices,” said market analyst Michael Hewson at CMC Markets.

Wall Street was mixed in late morning trading, with the Dow lower and the tech-heavy Nasdaq Composite higher.

“Remarkably, technology stocks surged higher after Wall Street opened for trading, despite the hawkish Fed yesterday,” said analyst Fawad Razaqzada at ThinkMarkets.

Top Fed officials on Wednesday maintained their ultra-easy monetary policy and repeated their belief that the sharp spikes in inflation were expected as businesses reopen and people return to daily lives.

But they advanced their timeline for a possible rise in interest rates, with the consensus for possibly two hikes by the end of 2023, a year sooner than their previous outlook. The prospect of rising global interest rates tends to hurt share prices because they increase the cost of loan payments, and Wall Street stocks closed lower on Wednesday.

Officials have for months pledged not to budge from their highly accommodative measures and will stay the course until unemployment is tamed and prices are rising excessively for a long period of time.

However, with the economic rebound looking well established, they have lately edged closer towards reducing or “tapering” stimulus measures, and Wednesday’s meeting highlighted that.

Fed boss Jerome Powell said the projections “do not represent a committee decision or plan” but that the bank was ready to alter policy if it sees signs inflation moved “materially and persistently beyond levels consistent with our goal” of two percent.

Inflation has surpassed that for the past three consecutive months and in May hit a 13-year high.

Powell also said the board had started talking about when to reel in its bond-buying scheme, which along with low rates and vast government stimulus has helped drive a rebound in equities from their April 2020 lows.

He said the Fed would give plenty of notice before making any major changes, and will “do what we can to avoid a market reaction”.

While many markets have hit record or multi-year highs in recent months, traders have been worried that the era of record low borrowing costs could be nearing an end soon as economies reopen.

“Uncertainty remains regarding if the Fed can manage its policy effectively amid festering inflation pressures and an accelerating economic recovery,” said analysts at Charles Schwab brokerage.

The greenback’s rise also weighed on dollar-priced oil, with both main contracts retreating from recent multi-year highs.

Meanwhile, the number of Americans filing new claims for unemployment benefits increased last week for the first time in 1-1/2 months, but layoffs are easing amid a reopening economy and a shortage of people willing to work.

While other data on Thursday showed factory activity in the mid-Atlantic region continuing to grow at a steady pace in June, a measure of future production surged to its highest level in nearly 30 years. Factories in the region that covers eastern Pennsylvania, southern New Jersey and Delaware also reported stepping up hiring, which bodes well for job growth this month.

The scarcity of labor is a hurdle to faster employment growth. The Federal Reserve on Wednesday held its benchmark short-term interest rate near zero and said it would continue to inject money into the economy through monthly bond purchases. The U.S. central bank brought forward its projections for the first post-pandemic interest rate hikes into 2023 from 2024.

“We continue to see labor market progress, but as has been the case through the pandemic, the situation remains fluid,” said AnnElizabeth Konkel, an economist at Indeed Hiring Lab. “We are in a wildly different place than we were in June 2020, but we have not crossed the finish line just yet.”