Stocks plunged on Tuesday after a better-than-expected inflation report pushed investors to rethink bets on how soon the Federal Reserve will take action to slow the economy and cut interest rates.
The benchmark S&P 500 stock index fell 1.4 percent. The index has suffered only one other loss of more than 1 percent this year, and optimism about the resilience of the economy and corporate profits continually pushes stocks to new highs.
Investors still hope the Federal Reserve will bring inflation to manageable levels without inflicting too much damage on the broader economy. But that forecast came under pressure Tuesday from a consumer inflation report that showed prices had been rising faster than expected.
The consumer data “was stronger than the Fed or the market wanted or expected,” said Greg Wilensky, head of U.S. fixed income at Janus Henderson Investors.
The longer inflation remains elevated, the longer the Federal Reserve is likely to hold off on rate cuts, tightening the screws on an economy that is already beginning to show some signs of weakness and tempering enthusiasm on Wall Street.
The two-year Treasury yield, which is sensitive to changes in investors’ expectations about interest rates, jumped nearly 0.2 percentage points to about 4.65 percent, the biggest jump in that market since March.
As market-based interest rates rose, so did the value of the dollar, putting pressure on currencies around the world, with the Japanese yen approaching its weakest levels since November.
Amid the choppy trading conditions, some companies chose to pause sales of new debt, preferring to wait until the market calmed down.
Stuart Kaiser, an equity analyst at Citi, said the inflation data was “not a game-changer” but would likely fuel a short-term contraction in the stock market as investors reduce hopes for rate cuts. . “The impression today was clearly not good,” he said.
Earlier this year, investors considered it highly likely that the Federal Reserve would begin cutting interest rates next month, after a sustained but bumpy decline in inflation. Investors have now abandoned their bets on a March cut, shifting expectations beyond the May Fed meeting to the next meeting in June.
“A cut in March is completely off the agenda,” said Seema Shah, chief global strategist at Principal Asset Management. “But May could still be in play if economic activity plays a role and finally begins to show the impact of the Fed’s earlier tightening.”
Investors and analysts were keen to point out that an inflation report would not dash hopes that the economy would avoid a serious recession.
A Bank of America survey of fund managers released Tuesday showed optimism was rising to the highest level since April 2022, shortly after the Federal Reserve began raising interest rates. This is supported by the fact that investors have been funneling cash into stock markets around the world, with allocations to US stocks being the highest since November 2021, according to the survey.
Those inflows have sent the S&P 500 up about 4 percent this year, even after Tuesday’s drop, and the index is also up about 20 percent since falling in October.
But some investors are concerned that the economy has not yet felt the full effect of the Federal Reserve’s rate increases, raising the risk that delaying rate cuts could lead the economy into a slowdown.
The Russell 2000 index, which tracks a wide range of smaller companies closely tied to the health of the national economy, fell 4.1 percent on Tuesday after posting extraordinary gains in recent trading sessions.
It marks the index’s worst daily performance since June 2022.
