The Dow Jones industrial average lost 394 points and the S&P 500 fell 53 points to their second lowest levels since the results of the Brexit referendum were released. The Dow Jones closed 2.1% lower at the end of the trading day and S&P 500 was down by 2.5%.
Comments by Federal Reserve Bank president Eric Rosengren fueled the downturn of the stock market, following his comments that the U.S. central bank should start raising its rates again. Earlier in the day the European Central Bank kept its rates flat. Wall Street analysts were surprised by the comments because he is known for his stance to keep interest rates low and his comments were quite unexpected by traders and analysts alike.
All the 30 blue chip companies comprising the DJIA index closed lower on Friday, while 98% of all companies listed in the S&P 500 were in the red. On the contrary, the dollar witnessed gains and the yield on the 10-year Treasury note TMUBMUSD10Y, +0.00% managed to reach peak levels that were not witnessed since before Brexit.
Rosengren commented that the U.S. economy is able to retain the present full employment level, which should result in gradual tightening of monetary policy.
“A failure to continue on the path of gradual removal of accommodation could shorten, rather than lengthen, the duration of this recovery,” he said in a speech at an event of the South Shore Chamber of Commerce in Quincy, MA.
If the interest rates go up, it is a signal for investors to transfer funds from corporate stocks into other financial instruments like government bonds and short-term deposits. As a rule, higher interest rates slow down the stock market and boost investment in other instruments. The markets are also disturbed by the uncertainty surrounding the U.S. presidential elections, which is an event that is a major driving force for the markets. Since there is no clear leader in the polls, the markets are nervous, which added to the recent downturn.
Rosengren also admitted that the economy is sending some mixed signals with the payroll employment being strong while real GDP growth for the first two quarters showing “disappointing” increase. Nevertheless, he added:
“My personal view, based on economic data that we have received to date, is that a reasonable case can be made for continuing to pursue a gradual normalization of monetary policy.”
This is exactly the remark that triggered the record decline of the stock market on Friday, with most traders fearing that interest rates increase and flat corporate profits will result in massive sales of corporate stocks.
Featured photo by reynermedia under Creative Commons Attribution 2.0 Generic License.