Stocks tumbled on Tuesday as investors pared back bets that the Federal Reserve would put the brakes on the economy in coming months as higher-than-expected inflation data led traders to expect interest rates to remain higher for longer.
The S&P 500 index fell more than 1%, the only day this year to see such a large drop, while optimism about economic resilience and corporate profits continued to push the stock market to new highs.
Investors still expect the Fed to bring inflation back to manageable levels without causing too much pain to the overall economy. But that forecast came under pressure after Tuesday’s consumer inflation report showed prices were rising faster than expected.
Greg Wilensky, head of U.S. fixed income at Janus Henderson Investors, said the consumer data was “stronger than either the Fed or the market wanted or expected.”
The longer inflation remains elevated, the longer the Fed will delay cutting interest rates, putting pressure on an economy that is starting to show some signs of weakness and dampening enthusiasm on Wall Street.
The two-year Treasury yield, which is sensitive to changes in investors’ interest rate expectations, jumped a tenth of a percentage point to about 4.6%, a sharp move in the market.
As market interest rates rise, the value of the dollar also rises, putting pressure on currencies around the world, with the yen approaching its lowest level since November last year.
Amid volatile trading conditions, some companies have chosen to suspend new debt issuances, preferring to wait until the market stabilizes.
Citi equity analyst Stuart Kaiser said the inflation data was “not a game changer” but could push stocks to tighten in the short term as investors give up hope of a rate cut. Print is obviously not a good thing,” he said.
At the beginning of this year, investors believed that the Federal Reserve was likely to start cutting interest rates next month after inflation continued to decline sharply. Investors have now given up bets on a rate cut in March, delaying expectations until after the Federal Reserve’s May meeting. Until the next show in June.
Seema Shah, chief global strategist at Principal Asset Management, said, “A rate cut in March is completely off the agenda. But if economic activity plays out and finally starts to show that before the Fed tightening policy, then the May rate cut may still play a role.”
Investors and analysts are keen to point out that an inflation report will not dash hopes that the economy will avoid a severe recession.
A Bank of America survey of fund managers released on Tuesday showed optimism rose to its highest level since April 2022, shortly after the Federal Reserve began raising interest rates. Investors have been pouring cash into global equities, as evidenced by the fact that allocations to U.S. stocks reached their highest levels since November 2021, surveys showed.
But some investors worry that the economy has not yet felt the full impact of the Fed’s rate hikes, raising the risk that delaying a rate cut could plunge the economy into a downturn.
The Russell 2000 index, which tracks a host of small companies closely tied to the health of the domestic economy, fell more than 3% on Tuesday after rising sharply in recent sessions.
If the index sustains these losses into the close, it would be its worst single-day performance since September 2022.