The US stock market was rocked by hotter-than-expected inflation data Tuesday as financial markets brace for the possibility that the Federal Reserve may keep interest rates higher for longer than hoped.
The S&P 500 Index is down 1.1% after core US consumer prices climbed by most in eight months. If that holds into the close, it will mark the gauge’s worst CPI-day since 2022, according to data compiled by Bloomberg.
“The concern (for bank stocks) is that the later the Fed begins with rate cuts, the greater the chance of a recession,” Wells Fargo’s Mike Mayo, the veteran banks stocks analyst, said by phone. “There’s very clear sentiment impact, and then the question is what degree does sentiment drive reality?”
Trading is turbulent as markets come to grips with the already-slim chances of the Fed lowering borrowing costs soon getting even slimmer. Indeed, these figures give the Fed ammunition to delay interest-rate cuts beyond what market was anticipating. Traders are responding, with swaps moving the pricing of rate cuts to July from June.
“There was a lot of hopes and dreams and hype in the market, and investors’ expectations will most likely reset after today’s CPI report,” Michael O’Rourke, chief market strategist at JonesTrading, said by phone. “It’s a notable step backwards, and you can’t ignore that. Today’s report pushed back everyone’s hopes for a rate cut to summer at best.”
The S&P 500 is approaching a technical roadblock after eclipsing 5,000 for the first time last week. The index is coming off five straight weeks of gains, rising in 14 of the last 15 weeks — something it hasn’t done since 1972.
However, a 22% rally in the S&P 500 since late October made positioning elevated and valuations stretched, raising anxiety about how much upside may be left in store for stocks. Equity positioning among systematic strategies jumped to the highest since December 2021, data compiled by Deutsche Bank AG show, while equity exposure among active mutual funds is hovering near 94%, according to a poll by the National Association of Active Investment Managers.
That partly explains the momentum behind Tuesday’s rout. The S&P 500 opened at 4,967.94, roughly 54 points below its 5,021.84 close on Monday. That’s the biggest opening down gap since October 2022.
In addition to the inflation fears, the stock market’s historical seasonality is at play. February has a tendency to start on a high note, although the strength typically fades around mid-month as investors book profits, according to Jeffrey Hirsch, editor of the Stock Trader’s Almanac. That’s particularly the case if stocks get a boost in January — like they often do — following tax-loss harvesting in December.
Wall Street’s reaction to CPI:
Mark Luschini, chief investment strategist at Janney Montgomery Scott:
Market participants had been conditioned to expect a linear decline in inflation. They were hoping numbers would cooperate with a glide path toward a 2% target, leading to the rate cuts that the market had priced in. This is certainly a step back in that narrative. The market was vulnerable. We’ve seen valuations expand far more than was warranted by earnings, and prices had become somewhat demanding. That means expectations needed to be satisfied, and this whiffed on expectations.
Matt Maley, chief market strategist at Miller Tabak + Co:
This shows the last mile to get inflation under control is still ahead of us, and this, in turn, shows the Fed is going to be slower to cut interest rates — something that’s not priced into the stock market. Today’s CPI report changes the narrative and the way the stock market will will assess policymakers’ pace of interest-rate cuts. Whether this is the beginning of a meaningful pullback is a big question, but after a four-month rally, it would be normal and healthy to have a correction.
Jeremy Abelson, founder and portfolio manager at Irving Investors:
This CPI number should test the confidence that the Fed has in its ability to cut rates right now. There is too much persistence of inflationary potential for them to consider cutting rates in the first half of this year. This number pushes back any rate cut until the second half but I think the buy-side was already starting to model that after the last Fed meeting. As it relates to IPOs and our late-stage venture investing, what the Fed is going to do as a standalone metric is irrelevant to us.
Thomas Martin, senior portfolio manager at Globalt Investments:
Fed Chair Powell said officials need more confidence that inflation is continuing to fall for a reason, so this data will certainly bolster that notion. This makes it more of a challenge for the Fed to cut rates and borrowing costs will likely come down more gradually as a result. As far as a bull case for stocks, this selloff probably won’t turn into a severe correction because the fundamental underpinnings for Corporate America are still good. Inflation will likely continue to decline while companies are still growing their earnings.
Steve Sosnick, chief strategist at Interactive Brokers:
Real estate is one of the most rate-sensitive equity sectors and thanks to this morning’s hotter-than-expected CPI results, we’re seeing rising yields across the curve and a reassessment of rate-cut timing. Put those factors together and you have real estate underperforming on a down day. Plus they have no AI exposure.
Michelle Cluver, senior portfolio strategist at Global X:
Continued economic resilience has the negative side effect of inflation potentially remaining stickier than expected. From an equities perspective, while there’s the initial period of interest rate expectations being reassessed, continued economic resilience and a reacceleration of earnings has the potential to support market performance and potentially even broaden market participation. This favors areas such as Industrials that are more sensitive to the economic cycle.
Mike Archibald, vice-president and portfolio manager at AGF Investments:
Equities are going to do fairly well this year but we’re probably going to see a lot of volatility such as this because the Fed has made it quite clear that they don’t want to make the mistake of cutting and then having to hike again.
Sam Stovall, chief investment strategist at CFRA:
The market had been feeling very content with the direction of inflation, earnings, and prices, and if anything was going to trip it up, it would be a reading like this. This reinforces our view that the Fed will start to cut rates in June, not May, and that the policy will be one that’s slower and lower. The cuts will be slower to come, and there will be fewer cuts for the full year.
George Cipolloni, portfolio manager at Penn Mutual Asset Management:
On the stocks side, I am a little cautious. The dividend yielding universe has not performed like broad S&P. You can’t buy things just on the basis of cheapness at the moment because you’re not going to get rewarded, and most value investors haven’t. I have to make sure that there’s a growth element involved in those names that we do buy.