The Dow Jones Industrial Average fell on Friday after the Federal Reserve’s decision to not extend a pandemic-era capital break for banks stoked a rise in bond yields and a sell-off in financials.
The blue-chip Dow slid 150 points, while the S&P 500 was down by 0.1%, off its lowest level of the day. The Nasdaq Composite traded 0.5% higher as investors bought the dip in tech shares.
The central bank on Friday declined to extend a rule expiring at the end of the month that relaxed the supplementary leverage ratio for banks during the pandemic. The rule allowing banks to hold less capital against Treasurys and other holdings was implemented to calm the bond market during the crisis and encourage banks to lend.
The decision could have some adverse effects, traders have warned, if in response banks sell some of their Treasury holdings. That could send yields even higher at a time when a rapid rise in rates is already unnerving investors.
“This is a disappointment to investors that the Fed decided not to extend it,” said Jimmy Chang, chief investment officer at Rockefeller Global Family Office. “There was a lot of expectation, at least a few weeks ago, that the Fed would extend to relieve SLR for the big banks given the need to absorb so much Treasury issuance.”
Bank stocks sold off in unison following the Fed’s decision. JPMorgan and Wells Fargo both slid more than 3%, while Goldman Sachs fell 1.5%. Bank of America also slipped 3%. These names got a lift earlier this week from rising rates and have all rallied double digits this year.
Meanwhile, bond yields bounced off their lows after the announcement. The 10-year Treasury yield reversed slightly higher at 1.74%, hovering near its 14-month high above 1.75% hit a day earlier. The benchmark rate started 2021 below 1%. (1 basis point equals 0.01%).
“The speed at which it came up to this level has been too rapid for comfort,” Chang said. “As yields move higher, it’s harder to justify the elevated valuation.”
Rising bond yields, which can signal confidence about the economic recovery, can also make high-growth stocks look less attractive to investors by diminishing the value of their future cash flows.
The major averages were on track to post a losing week with the Nasdaq being the relative underperformer. The S&P 500 is off by 0.9% this week and the Nasdaq is down 1.3%. The Dow has dipped 0.3%.
“The big fear is that some banks might resist lending because they might struggle putting more capital aside,” said Edward Moya, senior market analyst at OANDA. “Wall Street is closely going to follow the upcoming Treasury auctions and if bank interest is low, the bond market selloff could intensify.”
Shares of FedEx jumped 6% Friday after the delivery company beat expectations on the top and bottom lines for its fiscal third quarter.
Nike‘s stock slipped by 4% after third-quarter revenues were weaker than anticipated.