Premature Expiration: Rate Hike Concerns Spook Stocks

Stocks dipped today after St. Louis Fed president James Bullard said that the first rate hike could come as early as the first quarter of 2015. Bank like Morgan Stanley (MS), Goldman Sachs (GS), JPMorgan Chase (JPM) and Citigroup (C) fell.

Bloomberg News James Bullard, president of the St. Louis Federal Reserve Bank

The S&P 500 dropped 0.1% to 1,957.22, while the Dow Jones Industrial Average fell 0.1% to 16,846.13. The Nasdaq Composite was little changed at 4,379.05, while the small-company Russell 2000 finished off 0.2% at 1,180.71.

The Lindsey Group’s Peter Boockvar assesses Bullard’s statement:

James Bullard, the St. Louis Fed President, does not vote and is usually middle of the road on the dove/hawk scale but he is shifting into the hawk camp today. He thinks inflation "may" reach 2% by year end (vs year end 2015 that the FOMC dots show). He thinks the unemployment rate will drop below 6% by year end (FOMC dots estimate 2015). And, he sounds like Mark Carney of the BoE with this line, "markets don't appreciate how close Fed is to goals." His conclusion from this is he forecasts the first rate rise at the end of Q1 2015. Bottom line, in terms of markets and rate policy we can discount Bullard because he does not vote and Yellen and Dudley still rule the dovish roost. But, the reality of the recent unemployment rate and inflation data points to a sooner rather than later meeting of the Fed's mandates and certainly before the mid 2015 aggregate FOMC estimates and certainly earlier than stock market expectations .

Normally, the onset of tightening wouldn’t be so problematic for stocks, explain Strategas Research Partners’ Jason Trennert and Eri Sato, but these aren’t normal times:

Generally speaking, the old market bromide "three steps and a stumble" has been a reliable guide to the way the market will react as the Fed starts tightening. Initial Fed rate increases are usually the result of a strengthening economy and are, as such, dealt by investors with equanimity if not outright enthusiasm. It is, generally speaking, only after the third Fed tightening, that market participants start to worry that the central bank is "behind the curve" and start to worry about the end of the expansion. The good news is that, if history is any guide, bulls have little to fear about the initial stages of tightening. The bad news is that history may be totally irrelevant after a period in which short rates have remained so low for so long and after the Fed has quintupled the size of its balance sheets. Given the fact that the Fed's grand experiment is so unprecedented, our best guess is that financial assets may exhibit far more volatility in the initial stages of tightening this time around.

Under normal conditions, financials should be gaining if the Fed were to start hiking rates sooner. Instead, financials were the second-worst performing sector today, as banks got hit after New York Attorney General Eric Schneiderman sued Barclays (BCS) over its dark pools, causing the US-listed ADRs of the British bank to fall 7.4% to $14.55. While the largest dark pools in the U.S. are operated by European banks, U.S. banks are also getting hit. Morgan Stanley dropped 1.1% to $31.89, Citigroup fell 1.2% to $47.23, JPMorgan declined 0.2% to $57.39 and Goldman Sachs finished off 0.2% at $168.01.