The stock market experienced a significant downturn on Tuesday, with major indexes taking a hit as January's latest consumer price index (CPI) reading reignited concerns over inflation. Contrary to investor expectations that inflation was under control, the data served as a stark reminder that the Federal Reserve's battle against rising prices is far from over.
Kent Engelke, chief economic strategist and managing director at Capitol Securities Management, commented on the market's reaction, noting that "the markets just went too far, too fast, and the Fed's reality is setting in right now." This reality check led to a substantial drop in the Dow Jones Industrial Average, which fell by nearly 760 points at its low, closing down approximately 525 points, or 1.4%. Similarly, the S&P 500 and the Nasdaq Composite saw 1.4% and 1.8% declines, respectively.
The bond market also felt the impact, with Treasury yields surging as investors adjusted their expectations for future rate cuts by the Federal Reserve. The yield on the 2-year Treasury jumped 18.7 basis points to 4.654%, reaching its highest level since December 12.
Investors had previously priced in as many as six quarter-point rate cuts by the Fed this year, driving the S&P 500 above the 5,000-point milestone and pushing the Dow and Nasdaq toward record highs. However, the Fed had consistently made back against these expectations, with its dot-plot forecast indicating only three rate cuts in 2024 and Fed Chair Jerome Powell cautioning against the notion of rate cuts as early as March.
The January CPI data revealed a 0.3% increase, with the year-over-year rate dropping to 3.1% from 3.4%. The core rate, excluding volatile food and energy costs, rose by 0.4%, slightly above Wall Street expectations, leaving the year-over-year core rate unchanged at 3.9%.
The reaction to the CPI data led to the worst performance for all three major indexes on a CPI release day since September 13, 2022. Fed-funds futures traders have now primarily ruled out the possibility of a March rate cut, with the chances of a quarter-point cut by the Fed's May meeting falling to around 37%, down from over 60% on Monday and 100% a month ago.
Some analysts, like Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, warned that persistent inflation could force a reassessment of the Fed's rate-cutting plans and potentially lead to further rate hikes. Others, like Seema Shah, chief global strategist at Principal Asset Management, cautioned against overreacting to one month's data but acknowledged that the figures were not favourable for the Fed's 2% inflation target.
According to Engelke, the market's vulnerability to a sharp selloff was likely exacerbated by algorithmic trading. He suggested that a pullback to the 4,800-point level for the S&P 500 would be reasonable, with a further retreat to 4,600 if that support fails to hold. Such a correction could be beneficial in the long run, helping to "wring out the excesses" and reduce complacency in the market.
Comments