U.S. stocks are experiencing a decline on Wednesday as new inflation data reveals a continuous increase in prices for the third consecutive month. This unexpected rise in prices has dampened expectations for potential rate cuts by the Federal Reserve this year. There are concerns that efforts to control high price levels may be losing momentum.
The S&P 500 is experiencing a significant decline of 1.1% in early trading, making it one of the worst days of the year thus far. Similarly, the Dow Jones Industrial Average has dropped by 451 points or 1.2% as of 9:35 a.m. EST, while the Nasdaq composite has also seen a 1.1% decrease.
“There are still pockets of inflation scattered throughout the economy,” stated Joe Davis, the chief global economist at Vanguard.
Shoppers find it distressing as it could lead to increased prices at the store. Likewise, Wall Street is also concerned as it may discourage the Federal Reserve from implementing the desired interest rate cuts that traders have been anticipating and betting on.
The S&P 500 has already surged over 20% since Halloween, driven in part by the anticipation of a potential interest rate cut from the Federal Reserve. This move by the Fed, aimed at alleviating economic pressures, would likely boost investor confidence and lead to increased prices for stocks, bonds, cryptocurrencies, and other investment opportunities.
The Federal Reserve had been waiting for more evidence that inflation was steadily declining towards its target of 2%. Despite a promising slowdown last year, concerns have arisen that inflation may remain stagnant, as the inflation reports for January, February, and March all exceeded expectations, along with other economic data.
The release of CPI data caused an immediate drop in various assets, including bonds, bitcoin, and gold. According to the government, the rise in gasoline prices and rent accounted for more than half of the monthly increase.
Quincy Krosby, chief global strategist for LPL Financial, highlighted the question of whether the Fed can begin an easing cycle at the June FOMC meeting in a recent research note on the latest inflation numbers. According to Krosby, there are several upcoming inflation-related data releases before the meeting, which may influence the Fed’s decision. Although the possibility of a rate cut in June remains, Krosby noted that the narrative around it is becoming more challenging.
Investors clearly view the future as more complex. They have significantly reduced their expectations of the Federal Reserve cutting rates in June. According to CME Group’s FedWatch tool, the probability of a rate cut has dropped from almost 74% a month ago to just 25%.
Traders, on the other hand, have significantly altered their predictions by placing more emphasis on the Federal Reserve reducing interest rates only twice this year. Initially, they had forecasted a total of six or more rate cuts extending until 2024.
According to Brian Jacobsen, chief economist at Annex Wealth Management, it takes more than just two data points to establish a trend. However, if we see another reading similar to this one, the conversation among the Federal Reserve may shift from discussing when to cut rates to considering whether to hike them.
More hikes?
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High interest rates have the ability to undermine inflation as they have a slowing effect on the economy and negatively impact investment prices. The concern lies in the possibility that if interest rates remain high for an extended period, they could potentially trigger a recession.
Critics had already highlighted concerns about the overvaluation of the U.S. stock market based on various indicators. To make stock prices appear more reasonable, either interest rates had to decrease or companies’ profits had to improve. The expectation among Wall Street analysts is that the robust U.S. economy might bolster corporate earnings, albeit at the expense of potential rate cuts.
Ian Shepherdson, the chief economist at Pantheon Macroeconomics, is not entirely convinced that the recent CPI data, although concerning, indicates a consistent upward trend. He believes that it could be a temporary setback rather than a long-term trend.
“In a recent note, he expressed confidence that all the drivers of the post-COVID inflation boom are now moving in the right direction. Although there may be some bumps along the way, it is important to view any short-term disappointments within the context of the overall positive outlook.”
Lydia Boussour, an EY senior economist, expects that the CPI numbers will soon begin to decrease once again.
In a research note, she stated that the short-term inflation dynamics suggest a temporary halt to disinflation. However, she predicts a resumption of downward momentum in the upcoming months. Although the expectation is for the Federal Reserve to initiate an easing cycle in June and implement three rate cuts throughout the year, the latest data may sway a slight majority of policymakers towards anticipating fewer rate cuts in 2024 and a delayed start to the easing cycle.
Other analysts are strongly pessimistic about the possibility of rate cuts in the near future, and they may have valid reasons for their stance. Chair Jerome Powell and other officials, like Loretta Mester, the president of the Cleveland Fed, have emphasized that the primary consideration for the Fed’s decision to cut rates is when, or if, inflation will start to decline and return to the central bank’s target of 2%.
According to a research note by Greg McBride, chief financial analyst at Bankrate, the possibility of a June interest rate cut seems unlikely. McBride explains that inflation has exceeded expectations, and the lack of progress towards the 2% target is becoming a consistent trend. Additionally, with oil prices reaching a 5-month high, the headline Consumer Price Index has actually increased at a faster rate over the past year compared to February.
According to McBride, the latest inflation data is concerning and should be seen as a warning sign. He believes that there has been no improvement and the situation is actually getting worse.
Delta Air Lines and banking earnings
Big U.S. companies are eagerly announcing their first-quarter profits, and Delta Air Lines led the way with better-than-anticipated results.
The airline reported a robust demand for flights worldwide, with expectations of continued strength throughout the spring. As a result, its stock saw a 3.4% increase, and other airline stocks followed suit.
This Friday, all eyes will be on the banking industry as JPMorgan Chase and Wells Fargo, among others, release their earnings reports.
Real-estate investment trusts, utility companies, and other stocks that are typically sensitive to high interest rates experienced significant declines on Wall Street. Real-estate stocks within the S&P 500 saw a substantial 3% drop, marking the largest loss among all 11 sectors comprising the index.
Indexes in Europe experienced a decline in the stock markets abroad. Meanwhile, in Asian trading, stocks in Hong Kong managed to rise by 1.9%. However, in Shanghai, there was a 0.7% decrease after Fitch Ratings revised its outlook for China’s public finances.
