Wall Street Suffers Amid Hotter-Than-Expected Inflation Data

Wall Street encountered a reality check on Tuesday as hotter-than-estimated inflation data triggered a significant slide in both stocks and bonds. Equities retreated from their all-time highs following the release of the consumer price index (CPI), which surpassed estimates across the board. Treasuries sold off, with two-year yields reaching their highest level since before the Federal Reserve’s December “pivot.” Swap traders revised down their expectations for a central bank rate cut before July, while the VIX, the stock market’s “fear gauge,” surged the most since October.

“This CPI report caught a lot of people off guard,” said Chris Zaccarelli at Independent Advisor Alliance. “Many investors were expecting the Fed to begin cutting rates and were spending a lot of time arguing that the Fed was taking too long to get started – not appreciating that inflation could be sticky and not continue down in a straight line.”

The disappointing CPI data came after a recent decline in price pressures, which had fuelled expectations for rate cuts this year. The figures underscored the wait-and-see approach highlighted by Jerome Powell and a chorus of Fed speakers.

The S&P 500 dropped 1.4%, falling below 5,000 in its worst CPI day since September 2022. Rate-sensitive shares such as homebuilders and banks suffered losses, while Tesla Inc. led declines among megacaps. The Russell 2000 of small caps slumped about 4%. US 10-year yields surged 14 basis points to 4.31%, with the real yield hitting 2%. The dollar strengthened, sending gold below $2,000.

“It is too early to declare victory over inflation,” said Torsten Slok at Apollo Global Management. “Maybe the ‘last mile’ was indeed more difficult.”

The unexpected increase in CPI, particularly in Owners’ Equivalent Rent (OER), a shelter price indicator, raised concerns about the Fed’s approach to rate cuts. While the details suggest a potential “last mile problem,” some analysts believe the Fed may delay rate cuts until midyear or later.

“The CPI data has disrupted the string of Goldilocks growth and inflation data that had helped to lift the S&P 500 over 5,000,” said Brian Rose at UBS Global Wealth Management. “But it doesn’t change our positive fundamental outlook for 2024 of solid growth, further disinflation, and the start of Fed rate cuts in Q2 that is supportive of risk assets.”

Despite the setback, some analysts maintain a positive outlook for the year, emphasising the need for a comprehensive assessment of consumer prices before drawing definitive conclusions about Fed policy.

“Just as the Fed said it wouldn’t rush to cut rates even after several months of encouraging economic data, they’re not going to immediately reverse course just because of one hotter-than-expected CPI reading,” said Chris Larkin at E*Trade from Morgan Stanley. “Until proven otherwise, the longer-term cooling inflation trend is still in place.”

The impact of the CPI data on the Fed’s preferred inflation gauge remains to be seen, with economists awaiting the personal consumption expenditures price index excluding food and energy, due later this month.

In summary, Wall Street’s reaction to the CPI data underscores the ongoing uncertainty surrounding inflation and interest rate policy, with investors closely monitoring future economic indicators for further clarity on the Fed’s stance.