US stock markets closed lower on Wednesday as investors weighed the implications of a robust report on the services sector that raised concerns about inflation and interest rate hikes.
Services sector shows resilience amid pandemic
The US services sector, which accounts for more than two-thirds of the economy, expanded at a faster pace than expected in August, according to the Institute for Supply Management (ISM). The ISM non-manufacturing index rose to 54.5 last month, beating the consensus estimate of 52.5 and indicating strong growth in business activity, new orders, and employment.
The report also showed that prices paid by service providers for inputs surged to the highest level since July 2008, reflecting supply chain disruptions and labor shortages that have pushed up costs across the economy. The inflationary pressures in the services sector added to the worries that the Federal Reserve may have to tighten its monetary policy sooner than anticipated to keep inflation under control.
Fed faces dilemma over tapering and rate hikes
The Fed has been buying $120 billion worth of bonds per month to support the economic recovery from the pandemic-induced recession, but has signaled that it may start reducing or tapering its asset purchases later this year if the economy continues to improve. However, the central bank has also stressed that tapering is not a prelude to raising interest rates, which it expects to keep near zero until at least 2023.
The Fed’s stance has been challenged by some market participants who believe that the central bank is underestimating the inflation risks and should act more aggressively to prevent overheating. The latest data on the services sector added fuel to this debate, as it suggested that the economy is still resilient despite the Delta variant of the coronavirus and could withstand higher borrowing costs.
On Wednesday, Boston Fed President Susan Collins said that the Fed should “proceed carefully” with its next policy steps and avoid making “premature” decisions based on incomplete data. She also said that she expects inflation to moderate in the coming months as supply and demand imbalances ease.
Tech stocks lead market decline as bond yields rise
The prospect of higher interest rates weighed on the stock market, especially on growth-oriented sectors such as technology, which tend to be more sensitive to changes in discount rates. The Nasdaq Composite index fell 1.06% on Wednesday, while the S&P 500 index dropped 0.70%. The Dow Jones Industrial Average declined 0.57%.
The yield on the 10-year Treasury note, which moves inversely to its price, rose to 4.27% on Wednesday, its highest level since July. Higher bond yields make stocks less attractive relative to fixed-income securities and also increase borrowing costs for companies and consumers.
Apple Inc., one of the largest components of the Nasdaq and the S&P 500, fell 3.6% after reports that China had banned officials at central government agencies from using iPhones and other foreign-branded devices for work. The move could hurt Apple’s sales and production in its biggest overseas market.
Oil prices retreat after China trade data disappoints
Oil prices retreated from their seven-year highs on Wednesday after China reported weaker-than-expected trade data for August, raising concerns about slowing demand in the world’s second-largest oil consumer. China’s exports grew by 25.6% year-on-year in August, below the forecast of 30%, while imports rose by 33.1%, missing the estimate of 40%.
China’s trade performance was affected by several factors, including COVID-19 outbreaks, typhoons, port congestion, and semiconductor shortages. The data also underscored the challenges facing China’s economy amid regulatory crackdowns on various sectors and rising tensions with the US.
Brent crude oil futures, the global benchmark, fell 0.8% to $86.69 per barrel on Wednesday, while West Texas Intermediate (WTI) crude oil futures, the US benchmark, dropped 1% to $83.60 per barrel.