Fed Uncertainty Brings Volatility to Markets

U.S. stocks dropped sharply on September 9, with the S&P 500® Index falling 2.5%, its worst single-session loss in more than two months. The drop ended a relatively quiet summer for U.S. stocks, which had touched new highs in mid-August.

Here’s what you need to know about Friday’s market drop, and the outlook for stocks and bonds ahead:

What caused the market drop?

Conflicting comments from Federal Reserve policymakers created uncertainty about the direction the Fed will take with interest rates. In one camp, Fed Governor Daniel Tarullo said he wanted to see more signs of inflation before deciding that a rise in interest rates is necessary.

In the other camp, Boston Fed Bank President Eric Rosengren suggested there was a reasonable case for hiking the federal funds rate as soon as the next Federal Open Market Committee meeting later this month. That view was shared by San Francisco Fed Bank President John Williams, who recently said he thought it made sense for the Fed to start raising rates “sooner rather than later.” A surprise announcement about a Monday speech from Fed Governor Lael Brainard—who has generally supported keeping rates low—added to speculation the Fed may be preparing the markets for a rate hike.

Uncertainty about central bank policy outside the U.S. was another potential cause for Friday’s volatility. The European Central Bank opted Thursday for no new easing moves and Japanese bond yields have continued to rise. The two events have sent a message to markets that quantitative easing may have lost some of its efficacy and will not continue indefinitely.

What is the outlook for stocks and bonds?

Markets have been unusually calm this summer, and prolonged periods of low volatility can make markets susceptible to news and rumors. Given the emphasis the market is now placing on Fed policy—and the uncertainty surrounding it—we wouldn’t be surprised to see markets continue to experience volatile swings when news or economic data suggest the Fed may, or may not, raise interest rates.

But even if the short-term pullback in stocks persists, we do not believe the longer-term bull market—which has been underway since 2009—is dead. U.S. economic data has generally shown signs of strength, and an improving economy should support the stock market over the long term.

As for bonds, while rising interest rates can translate into falling bond prices—bond yields typically move inversely to bond prices—it’s important to remember that yields generally don’t move in tandem all along the yield curve. The Fed influences short-term interest rates, but long-term interest rates are generally affected by other factors, such as economic growth and inflation expectations. And even if the Fed does raise short-term interest rates again this year, we anticipate that future rate hikes would be gradual, as inflation remains low and the U.S. economy is only growing moderately.

What should investors do now?

Resist overreacting to swings in the market. Stock market fluctuations are a normal part of investing; panicking and pulling money out of the market may mean missing out on a potential rebound.

That said, periods of market volatility are a good time to review your risk tolerance, and make sure your portfolio is aligned with your time horizon and investing goals. A well-diversified portfolio, with a mix of stocks, bonds and cash allocated appropriately based on your goals and risk tolerance, can help you weather periods of market turbulence.

Next Steps

Talk to Us

To discuss how this article might affect your investment decisions:

-          Call Schwab anytime at 800-355-2162.
-          Talk to a Schwab Financial Consultant at your local branch.

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