Why U.S. stock-market investors are rattled by the Bank of Canada’s surprise rate hike

The Bank of Canada delivered another reminder to U.S. investors Wednesday that pressing “pause” on interest rate hikes doesn’t necessarily mean the monetary tightening cycle is over.

The Bank of Canada somewhat surprised traders by delivering a quarter percentage point hike in interest rates, ending a four-month pause. An uptick in the April inflation reading and still strong consumer spending convinced policy makers to resume hikes. The Reserve Bank of Australia on Tuesday delivered a second straight rate hike after having ended a short pause of its own.

That complicates the picture for U.S. investors, who are motivated to get bullish ahead of a Fed pause, which historically has accompanied stock-market rallies, said Louis Navellier, founder of Navellier & Associates, in a note.

Australia and Canada “have raised rates in the face of a slowing economy due to stubborn inflation trends, as stagflation is seen as worse than suffering through a recession to break inflation,” he wrote. “Our Fed could reach the same conclusion and estimates are that it may take a 6% rate to slow things enough to actually reach a 2% inflation rate.”

See: Watch the U.S. dollar. Will Fed follow suit after Australia’s surprise rate hike?

Investors look for the Federal Reserve to deliver a pause of its own next week, with policy makers expected to leave the fed-funds rate unchanged after hiking it from near zero to 5% to 5.25% in a breakneck series of rate hikes that began in March 2022.

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“Interpret the dot plot and officials comments all you want, but central bankers will flip and ignore everything they had said if the data demands it,” tweeted Jeffrey Kleintop, chief global investment strategist at Charles Schwab & Co., after the BOC decision.

Fed-funds futures traders appear to be taking Fed officials at their word, after they hinted last week that a pause in June could still be followed by a hike. The market has priced in a 64% probability the fed-funds rate will remain unchanged on June 14, down from around 78% on Tuesday, according to the CME FedWatch tool The market has priced in only a 31% probability the rate won’t rise by the Fed’s July 26 policy decision.

U.S. Treasury yields extended a rise after the Canadian decision, while U.S. stocks faltered. The S&P 500

fell 0.4% after ending Tuesday at its highest since August. The large-cap benchmark briefly traded above the threshold that would see it exit a bear market in morning trade, before coming under pressure after the Bank of Canada’s announcement.

The rise in yields saw the tech-heavy Nasdaq Composite

slump 1.3%, while the Dow Jones Industrial Average

ended the day up 91.74 points, or 0.3%.