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Frazzled U.S. stock investors eye frothy Treasury market as Fed looms

Traders work on the floor of the NYSE in New York

By David Randall

NEW YORK (Reuters) -Financial markets are bracing for what could be a momentous week, with a Federal Reserve meeting, U.S. employment data and earnings from technology heavyweight Apple Inc possibly setting the course for stocks and bonds the rest of the year.

October has lived up to its reputation for volatility, as a surge in Treasury yields and geopolitical uncertainty pressured stocks. The S&P 500 index is down 3.5% for the month, adding to losses that have left it over 10% off its late-July high.

Whether the ride remains rough for the rest of 2023 may depend in large part on the bond market. The Fed's 'higher for longer' stance on interest rates and rising U.S. fiscal worries pushed the benchmark 10-year Treasury yield - which moves inversely to prices - to 5% earlier this month, the highest since 2007. Higher Treasury yields are seen as a headwind to stocks, in part because they compete with equities for buyers.

Investors worry that yields could rise further if the Fed reinforces its hawkish message at the central bank's Nov. 1 monetary policy meeting. Strong U.S. employment data next Friday could also be a catalyst for yields to rise if it bolsters the case for keeping rates elevated to cool the economy and prevent inflation from rebounding.

"Stocks will start to recover when the market believes that bond yields have peaked," said Sam Stovall, chief investment strategist at CFRA Research.

Overall, futures markets are pricing in a near-certainty that the Fed does not raise rates in November, and a nearly 80% chance that the central bank holds rates steady in December, according to CME's FedWatch Tool. Still, policymakers have projected they will keep the key policy rate at current levels through most of 2024, longer than markets had previously anticipated.

Investors are playing a "waiting game of how much does each economic data point need to increase to put another rate hike back on the table," said Alex McGrath, chief investment officer for NorthEnd Private Wealth.

With U.S. Gross Domestic Product growth at a sizzling 4.9% in the third quarter, signs that the labor market remains too hot, or the Fed sees the need for further tightening to control inflation, could fuel further volatility.

"It feels like we are at a crossroads whether or not the strong growth we've seen over the summer months will continue over the fourth quarter," and keep worries over inflation and restrictive monetary policy bubbling, said Charlie Ripley, senior investment strategist for Allianz Investment Management.

Adding to the bond market's concerns, the Treasury is expected to announce its upcoming auction sizes later this week. Worries about a growing federal deficit and increased supply have helped push yields higher.

Investors are also awaiting Apple's results on Thursday, during an earnings season with disappointments from some growth and technology giants, including Tesla and Google. The tech-heavy Nasdaq 100 index is down 11% from its high, though still up nearly 30% on the year.

Some investors believe the worst of the selling may be over.

A stock market rebound would follow seasonal trends, said Stovall, of CFRA Research. Since 1945, the S&P 500 has advanced by an average of 1.5% in November, making it the year's third-best performing month, he said.

More broadly, some believe the stock market's trading patterns this year point to a rebound in the fourth quarter.

In the 14 instances when the S&P 500 has gained at least 10% through July and then declined in August, as it did this year, the index has increased every time over the last four months of the year, according to Ned Davis Research. The average gain in those instances has been 10%.

Stocks appear "oversold" according to technical indicators and could rally if economic data comes in as expected, said Randy Frederick, managing director of trading and derivatives for the Schwab Center for Financial Research.

"The stock market is poised for a late Q4 rally."

(Reporting by David Randall; Editing by Ira Iosebashvili and Richard Chang)