Investors Confront the Federal Reserve’s Reality in Inflation Battle, as Evidenced by the Stock-Market Downturn

Investors Confront the Federal Reserve’s Reality in Inflation Battle, as Evidenced by the Stock-Market Downturn

Reality hit hard for investors on Tuesday as the stock market experienced a significant drop. The cause? An unexpectedly high consumer-price index (CPI) reading for January, which served as a reminder that the Federal Reserve’s ongoing fight against inflation is far from over. The Dow Jones Industrial Average plummeted nearly 760 points at its lowest point, ending the day down approximately 525 points or 1.4%. The S&P 500 and Nasdaq Composite also took a hit, falling 1.4% and 1.8% respectively.

The steep decline in the stock market prompted a sharp sell-off in Treasuries, leading to soaring yields. The 2-year Treasury yield jumped 18.7 basis points to 4.654%, reaching its highest level since December 12. The January consumer-price index rose by 0.3%, with the year-over-year rate dropping to 3.1% from 3.4% in the previous month. The core rate, which excludes volatile food and energy costs, rose by 0.4%, slightly above Wall Street expectations.

Investors were reminded that CPI release days can be volatile, as all three major indexes experienced their worst performance on a CPI day since September 13, 2022. The sudden downturn in the market highlighted the fact that investors had believed inflation concerns were behind them. Many had priced in up to six quarter-point rate cuts by the Federal Reserve this year, propelling the S&P 500 above the monumental 5,000-point mark just a week ago. The Dow Jones Industrial Average also achieved record-high closes, while the Nasdaq Composite neared its own record territory.

However, the Federal Reserve had consistently pushed back against these expectations. Their dot-plot forecast indicated only three rate cuts in 2024, and Fed Chair Jerome Powell and other officials had cautioned against the idea that rate cuts could come as early as March. As a result of the recent CPI data, traders in Fed-funds futures have mostly abandoned the prospects of a March rate cut, with a 37% chance of at least a quarter-point cut by the Fed’s May meeting. This is down from over 60% on Monday and 100% a month ago. Traders now predict a little over a 50% probability of a total of four quarter-point cuts by the end of the year.

While some observers believe that one month’s data should not be overanalyzed, they acknowledge that the figures are not good news for Fed policymakers. Chris Zaccarelli, Chief Investment Officer for Independent Advisor Alliance, suggests that the high core CPI figure of 3.9% may not only impact the timing of rate cuts but also opens the possibility of a future rate hike. On the other hand, Seema Shah, Chief Global Strategist at Principal Asset Management, advises against jumping to conclusions about an inflationary resurgence based on this data.

Kent Engelke, Chief Economic Strategist and Managing Director at Capitol Securities Management, believes that stocks had accounted for all the positives prior to Tuesday’s data release, leaving the market vulnerable to a sharp selloff. Engelke suggests that a near-term pullback could be beneficial for the rally, stating that a retreat to the 4,800-point level for the S&P 500 would be reasonable, with 4,600 in sight if that level of support fails.

In conclusion, Tuesday’s stock-market downturn serves as a reminder that the Federal Reserve’s battle against inflation is ongoing. The unexpectedly high CPI reading for January shattered investor expectations and led to a sell-off in Treasuries. While some investors are concerned about the implications of this data, others urge caution in overreacting. Regardless, the market may benefit from a pullback, allowing for the elimination of excesses and reducing complacency among investors.