An unexpected inflation jump in August set stocks plunging Tuesday as Wall Street braced for steeper Federal Reserve rate hikes and a potential economic slowdown.
The Dow Jones Industrial Average closed with at a loss of 3.9 percent, a decline of more than 1200 points, after the Labor Department released a surprisingly hot consumer price index (CPI) report earlier in the day.
The S&P 500 fell 4.3 percent and the Nasdaq composite sunk 5.1 percent on the day. All three major indexes suffer their worst day of losses this year.
Markets began selling off after the Labor Department reported a 0.1 percent increase in the CPI, a closely watched gauge of inflation, in August.
While the size of the increase was relatively small, it defied economists’ predictions of an overall decline in prices in August. Prices for food, shelter, medical care and basic consumer staples also rose sharply in August, causing alarm among investors and concern about how the Federal Reserve would respond.
“US stocks are crumbling after a very hot inflation [report] has Wall Street nervous that they were too optimistic in forecasting the end of the Fed’s tightening cycle,” wrote Edward Moya, senior market analyst at trading firm OANDA.
“The Fed will likely have to be even more aggressive with raising rates and that is bad news for risky assets,” Moya added.
Stocks have fallen steadily throughout the year as the Fed has hiked interest rates to bring inflation down. Higher Fed interest rates tend to weaken the stock market as companies face higher borrowing costs and slower sales. Rate hikes also push companies away from hiring and investing in their operations, which makes stocks less attractive to hold.
The Fed was already on track to hike its baseline interest rate range by 0.75 percentage points at the Sept. 20 and Sept. 21 meeting of the Federal Open Market Committee (FOMC), the panel of Fed officials responsible for setting interest rates. It would be the third consecutive FOMC meeting to end with a 75 basis point hike, a rapid set of rate hikes by the Fed’s historical standards.
The August inflation jump not only cements the Fed’s plans for a 75 basis point hike next week but may also make the central bank more likely to keep boosting rates higher. Some stock traders had expected the Fed to slow down or even pause its rate hikes after the economy slowed sharply during the second half of the year and the labor market showed signs of expanding.
“Premature calls for the Federal Reserve to pause or pivot on its campaign to tame inflation should be politely dismissed given the 0.1% increase in top-line inflation in August,” wrote Joe Brusuelas, chief economist at tax and audit firm RSM, in a Tuesday analysis.
“Even though supply chain snarls are easing, gasoline prices are falling and global aggregate demand is cooling, for the Fed to pull back on its current policy path would be a strategic error of epic proportions,” Brusuelas added.
Fed Chair Jerome Powell has vowed to keep raising interest rates as high and for as long as necessary to bring inflation down. He and other Fed officials have insisted the bank will not relent until inflation is well on its way back to the bank’s 2 percent annual target, three times lower than it was in August.
Many economists fear that the slowdown could escalate into a full-blown recession with negative economic growth and job losses if the Fed keeps hiking rates at a blistering pace.
“Higher interest rates, slower growth and softer labor market conditions will bring down inflation. They will also bring some pain to households and businesses,” Powell said last month.
Updated at 4:01 p.m.