The Dow Jones Industrial Average closed Friday below the key 17,000 mark after spending a few days testing that level — a line in the sand that was first crossed back in July. The index has been lazily resting on this level for the last three weeks, but the bulls just couldn't hold it anymore. Stocks posted their first weekly loss since the beginning of August.
The catalyst for the move wasn't related to geopolitics, foreign affairs, or even the economic or market activity in Europe or Asia. It's being driven by the same catalyst that's stood above all else over the last five years: The Federal Reserve.
This week could be more of the same, as the market waits to get the latest signal from Fed policymakers on just when they might raise key interest rates for the first time since 2006.
Related: The Interest Rate Guessing Game Is Back in Style
Yield-sensitive areas like utilities, real estate and homebuilder stocks have already been under pressure. The iShares Real Estate (IYR), on an intra-day basis on Friday, suffered its worst one-day loss since June 2013 (which was in the midst of last year's "taper tantrum" related to the end of the Fed's QE3 bond buying stimulus). Treasury bonds are under pressure as well, with the selling carrying an intensity that we haven't seen since November.
You see, a steady drumbeat of solid economic data (including a bounce back in retail sales reported Friday) has forced investors — who even the Fed has called out as being way too dovish in their expectations of the pace and timing of interest rate hikes due to start next year — to come to the realization that the era of near-zero interest rates is about to end.
Related: Investors in Denial Over Coming Fed Rate Hikes
Everyone is now turning their attention to the outcome of next Wednesday's Fed meeting for changes to the policy statement and individual economic projections. The pace and timing of interest rates hikes are expected to be brought forward, with the Fed dropping its promise to keep rates low for a “considerable time” after the end of its QE3 bond-buying stimulus program next month. The individual projections of Fed officials are sure to be revised higher both in terms of estimates for economic growth and job creation.
Wall Street analysts are responding, which is why the market has destabilized in recent days. J.P. Morgan is now looking for the first Fed rate hike in June vs. their prior call for a move sometime in the third quarter. Analysts at Bank of America Merrill Lynch have also penciled next June as the timing for the Fed's first rate hike, pulling it back from next September.
The Merrill Lynch economists also believe the Fed will replace it’s “considerable time” phrase with "considerable economic improvement" in order to reinforce the data dependency of the Fed's action. But it's anyone's guess what the Federal Open Market Committee members will do.
It's worth noting that Fed Chair Janet Yellen's first press conference early this year was marred by her mentioning, in passing, that she believed a "considerable time" represented something like six months. The market sold off heavily on those words, which Yellen quickly walked back.
Related: What Happens When the Fed Stops Propping Up Stocks?
As for the individual rate hike projections, Bank of America Merrill Lynch is looking for an upward drift that puts the median expectation for the Fed's short-term policy interest rate at year-end at 1.25 percent for 2015 and either 2.25 percent or 2.5 percent for 2016.
The fact that we're talking about when and how quickly interest rates rise is a major shift. For years, Wall Street was boosted by cheap money stimulus programs, both here and abroad. Witness the recent announcement of a new bond buying program by the European Central Bank, for instance.
But things are set to change, as the Fed is set to embark on a tightening cycle. Stock and bond prices should continue to suffer volatility as the new environment gets fully priced in.
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