Dow slides 400 points on fears the Fed will keep tightening into a recession

Investors should prepare for a volatile market in January, says BofA's Savita Subramania

Stocks fell on Monday on concerns that the Federal Reserve may continue to tighten until it steers the economy into recession.

The Dow Jones Industrial Average fell 410 points, or 1.2%, while the S&P 500 and Nasdaq Composite fell 1.5% and 1.6%, respectively.

A worse-than-expected November ISM Services reading further fueled concerns that the Fed will continue to hike. The index recorded a value of 56.5%, beating the Dow Jones estimate of 53.7% and rising since October.

Bond yields were pushed higher as stocks fell, with the yield on the benchmark 10-year treasury last trade was up 8 basis points to 3.586%.

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“It’s clear that equity markets want to move higher, but that very much depends on whether inflation gets under control,” said Peter Essele, head of portfolio management at Commonwealth Financial Network. “And so when you have above-expected prints on any economic number that comes out, that tends to fuel inflationary concerns, which pushes rates up.”

In other news, Tesla shares fell about 4% on reports of production cuts at its Shanghai factory, while shares of Macau-linked casinos gained hope for an easing of Covid-19 restrictions.

Investors are watching for new economic data ahead of next week’s Federal Reserve meeting. After last week’s speech by Fed Chairman Jerome Powell, markets mostly expect the central bank to approve a 0.5 percentage point increase in interest rates. That would mark a step down from a run of four straight increases of 0.75 percentage points.

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But Powell also said the “terminal rate,” or the point at which the Fed stops hiking, would likely “have to be a little bit higher” than indicated at the September meeting. That could mean the Fed funds rate ending above 5%, from the current target range of 3.75%-4%.

Friday’s nonfarm payrolls report added to Fed market jitters as average hourly earnings rose more than expected. Wage pressures on inflation could force the Fed to take an even more aggressive stance.

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The major averages are coming in for the second positive week in a row.

Despite the recent rally, Mike Wilson, chief U.S. equity strategist at Morgan Stanley, said investors should consider profit-taking because the stock’s risk-reward is likely limited as the S&P nears the bank’s original tactical target range of 4,000 to 4,150.

“As suggested two weeks ago, for this tactical rally to increase, back-end rates would have to fall,” he said in a note to clients on Monday. “Fast forward to today and that is what happened. However, we are now right at our original bullish targets and recommend taking profits before the bear actually returns.”

CNBC’s Jeff Cox contributed reporting


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