Stocks fall on dashed inflation hopes; The S&P 500 loses 3%

NEW YORK — Stocks tumble and disappointment hits markets around the world on Tuesday, following the sudden realization on Wall Street that inflation is not slowing as much as hoped.

Them&P 500 was down 3% in afternoon trading, threatening to snap a four-day winning streak. Bond prices also fell sharply, pushing up their yields, after a report showed inflation slowed to just 8.3% in August, from the 8.1% expected by economists. .

The warmer-than-expected reading means traders are bracing for the Federal Reserve to eventually raise interest rates even higher than expected to fight inflation, with all the risks to the economy that entails. Fears over higher rates have sent prices plummeting for everything from gold to cryptocurrencies to crude oil.

“Right now, it’s not so much the journey that’s of concern as the destination,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments. “If the Fed wants to rise and hold, the big question is how high.”

The Dow Jones Industrial Average was down 882 points, or 2.7%, at 31,499 as of 12:45 p.m. EST, and the Nasdaq composite fell 3.8%. Big tech stocks faltered more than the rest of the market as the 11 sectors that make up the S&P 500 sank.

Most of Wall Street entered the day expecting the Fed to raise its key short-term rate by three-quarters of a percentage point at its meeting next week. But the hope was that inflation was rapidly falling back to more normal levels after peaking in June at 9.1%.

The idea was that such a slowdown would allow the Fed to scale back the magnitude of its rate hikes through the end of this year and then potentially hold steady through early 2023.

Tuesday’s report dashed some of those hopes. Many of the data points in it were worse than expected by economists, including some the Fed pays close attention to, such as inflation outside of food and energy prices.

Markets focused on a 0.6% rise in those prices in August from July, double what economists expected, said Gargi Chaudhuri, head of investment strategy at iShares.

Inflation numbers were so much worse than expected that traders now see a one in five chance of a full percentage point rate hike by the Fed next week. That would be four times the usual move, and no one in the futures market was predicting such a rise a day earlier.

Traders now see a greater than 60% chance that the Fed will raise its federal funds rate to a range of 4.25% to 4.50% by March. A day earlier, they were seeing less than a 17% chance of such a high rate, according to CME Group.

The Fed has already raised its benchmark interest rate four times this year, the last two increases by three-quarters of a percentage point. The federal funds rate is currently in a range of 2.25% to 2.50%.

“The Fed cannot let inflation persist. You need to do whatever is necessary to keep prices from rising,” said Russell Evans, managing director of Avitas Wealth Management. “This indicates that the Fed still has a lot of work to do to bring inflation down. “

Higher rates hurt the economy by making it more expensive to buy a house, car, or anything else purchased on credit. Mortgage rates have already reached their highest level since 2008, creating difficulties for the housing industry. The hope is that the Fed can successfully walk the tightrope of slowing the economy enough to quell high inflation, but not so much as to create a painful recession.

Tuesday’s data puts hopes of such a “soft landing” under greater threat. In the meantime, higher rates also drive down the prices of stocks, bonds, and other investments.

Investments considered the most expensive or riskiest are the hardest hit by rising rates. Bitcoin fell 6.7%.

In the stock Exchangeall but seven of the stocks in the S&P 500 fell. Technology and other high-growth companies fell more than the rest of the market as they are considered most at risk from higher rates.

Apple, Microsoft and Amazon all fell more than 4% and were the heaviest hitters in the market. The communications services sector, which includes parent Google and other internet and media companies, fell 4.3% in the biggest loss of the 11 sectors that make up the S&P 500 index.

Granted, losses only return the S&P 500 close to where it was before its recent winning streak. This run was built on hopes that Tuesday’s inflation report would show a more comforting slowdown. The ensuing wipeout matches what has become a trend on Wall Street this year: stocks fall on inflation worries, rise in hopes the Fed might ease rates, then fall again when the data undermines those hopes.

Tuesday’s inflation report came before trading began on Wall Street, but it sent a thud through markets around the world.

Treasury yields immediately jumped on expectations of a more aggressive Fed. The two-year Treasury yield, which tends to track Fed stock expectations, climbed to 3.75% from 3.57% late Monday. The 10-year yield, which helps dictate the direction of mortgages and other loan rates, rose to 3.43% from 3.36%.

Stock markets in Europe, meanwhile, swung from gains to losses. The German DAX lost 1.6% and the French CAC 40 fell 1.4%.

Expectations of a more aggressive Fed also helped the dollar add to its already strong gains for this year. The dollar surged against the euro, Japanese yen and other currencies, largely because the Fed raised rates faster and with wider margins than many other central banks.

An index measuring the value of the dollar against several major currencies rose 1.2%.

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AP Business Writer Damian J. Troise contributed.

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