ASX in the red as Fed spooks markets

The local sharemarket finished the session down 1.8 per cent, with fund managers warning volatility is here to stay.

Australian shares swung strongly into the red on Thursday, ending down 1.8 per cent to 6857.9 points, spooked by comments from Federal Reserve chair Jerome Powell that pointed to US interest rates remaining higher for longer.

All bar one sector finished in negative territory, with consumer stocks among the hardest hit as investors brace for rates and inflation to stay higher for longer.

And the volatility will continue until rampant inflation is under control, fund managers warned.

“The market is now forming the view that although the pace of interest rate hikes will slow, we are moving toward a higher and probably more sustained terminal rate,” LGT Crestone head of public markets Todd Hoare said.

Just days ago, markets priced a peak federal funds rate of 4.96 per cent. Now, the market sees a terminal rate above 5 per cent.

“So (rate expectations) have gone up. As well as that, the expectations for rate cuts are still there as we move forward to 2024, but they’re now from a higher level. That’s what the market’s having to grapple with at the moment,” Mr Hoare said.

The swift market decline follows weeks of gains. While the S&P/ASX 200 is up 6 per cent in just over a month – even after Thursday’s drop – the Dow is up 12 per cent and the S&P 500 has gained 5 per cent.

Such sharp moves are typical of bear market rallies, Mr Hoare added. “As you get deeper and longer into (a bear market), and we’re now into the 11th month of this one, the rallies typically get a bit more violent and a bit larger,” Mr Hoare warned.

That trough is still a while off, with Mr Hoare anticipating the earnings recession only a fraction of the way through. He sees no reprieve until mid 2023.

On rates, the RBA is on a similar trajectory to the US Fed, though Australia’s terminal – or peak – rate isn’t tipped to get close to 5 per cent. This could see Australia escape the worst of the market impact, Mr Hoare suggested.

“The conditions that we‘re seeing in the US and Europe and other parts of the world will, to some degree, also affect Australia. At the end of the day, what the market is really focused on is that higher interest rates globally will slow aggregate demand,” Mr Hoare said.

“There will be a flow of funds, potentially from equities into other asset classes, like fixed income. And so that‘s a global issue that Australia will not be immune to. We will be better protected, but I don’t think we’ll be immune.”

Thursday’s share price falls came after the US central bank overnight hiked rates by 75 basis points for the fourth consecutive month, taking the benchmark federal-funds rate to a range between 3.75 per cent and 4 per cent.

While Wall Street initially took the rise in its stride, amid expectations of a slower rate rise pace, the market quickly turned as Mr Powell made it clear that interest rates would climb to higher levels than officials anticipated just weeks ago – and remain elevated for longer.

The Dow finished 1.55 per cent in the red, while the S&P 500 tumbled 2.5 per cent and the Nasdaq fared even worse, losing 3.4 per cent by the end of the session.

Mr Powell’s comments also spooked the local sharemarket, Ophir Asset Management director Andrew Mitchell said.

“Today’s drop on the ASX shows the market has been reluctant to let go of the idea that a Fed pivot is just around the corner,” he said. “Having rallied about 8 per cent from their September lows, it doesn’t surprise us to see some weakness as the bar for a Fed U-turn keeps getting pushed higher. It’s third-quarter earnings season in the US, but this is still a Fed and macro-dominated market.”

Locally, the sharemarket trimmed its losses through Thursday’s trade, falling as much as 2.3 per cent to a three-day low of 6823 before US futures delivered a glimmer of hope, turning up 0.2 per cent and helping local stocks edge back below a 2 per cent loss. Materials, consumer discretionary and utilities led the declines, all down more than 2.2 per cent, followed by real estate and consumer staples, again suffering a more than 2 per cent over the session.

Communications services was the only sector to eke out a gain in, up 0.14 per cent.

Steven Glass, managing director of Pella Funds Management, expects markets to remain volatile through the end of the year and is tipping a US recession that could spark further market disruption.

There is every chance this “disruption” will spill over into other markets, including the ASX. “What we’re really concerned about is when quantitative tightening comes in full bore, which it hasn’t yet,” Mr Glass said.

“Earlier this year, the Fed said they were prepared to allow their balance sheet to decline by up to $95bn per month. To date, they have been (shrinking it) by $50bn per month. So they’ve been really slow compared to what they said they would do.

A tighter Fed could have “huge ramifications” for markets in 2023, he warned. Not only that, but markets are still not pricing in an earnings recession that Mr Glass also expects to hit next year.