Wall Street’s realisation that inflation got worse last month, not better as hoped, sent markets reeling on Friday.
The S&P 500 sank 2.9 per cent for a ninth losing week in the last 10, and tumbling bond prices sent Treasury yields to their highest levels in years. The Dow Jones Industrial Average lost 2.7 per cent, and the Nasdaq composite dropped 3.5 per cent.
Wall Street came into Friday hoping a highly-anticipated report would show the worst inflation in generations slowed a touch last month and passed its peak. Instead, the US government said inflation rose to 8.6 per cent in May from 8.3 per cent a month before.
The Federal Reserve has begun raising interest rates and making other moves to slow the economy in hope of forcing down inflation.
Wall Street took Friday’s reading to mean the Fed’s foot will remain firmly on the brake for the economy, dashing hopes that it may ease later this year.
“Inflation is hot, hot, hot,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments. “Basically, everything was up.”
The growing expectation is for the Fed to raise its key short-term interest rate by half a percentage point at each of its next three meetings, beginning next week. That third one in September had been up for debate among investors in recent weeks. Only once since 2000 has the Fed raised rates by that much, last month.
“No relief is in sight, but a lot can change between now and September,” Mr Jacobsen said. “Nobody knows what the Fed will do in a few months, including the Fed.”
The nation's high inflation, plus the expectations for an aggressive Fed, have sent the two-year Treasury yield to its highest level since 2008 and the S&P 500 down 18.7 per cent from its record set in early January.
The worst has hit high-growth technology stocks, cryptocurrencies and other particularly big winners of the pandemic's earlier days. But the damage is spreading as retailers and others are warning about coming profits.
The S&P 500 fell 116.96 points to 3,900.86. Combined with its losses from Thursday, when investors were rushing to lock in final trades before the inflation report, it was the worst two-day stretch for Wall Street’s benchmark in nearly two years.
The Dow lost 880.00 points to 31,392.79, and the Nasdaq tumbled 414.20 to 11,340.02.
Stock prices rise and fall on two things, essentially: how much cash a company produces and how much an investor is willing to pay for it. The Fed's moves on interest rates heavily influence that second part.
Since early in the pandemic, record-low interest rates engineered by the Fed and other central banks helped keep investment prices high. Now, the “easy mode” for investors is abruptly and forcefully getting switched off.
Not only that, too-aggressive rate rises by the Fed could force the economy into a recession. Higher interest rates make borrowing more expensive, which drags on spending and investments by households and companies.
One of the fears among investors is that food and fuel costs may keep surging, regardless of how aggressively the Fed moves.
“The fact is that the Fed has very little ability to control food prices,” Rick Rieder, BlackRock's chief investment officer of global fixed income said.
He pointed instead to mismatches in supplies and demand, higher costs for energy and wages and the war in Ukraine, which is a major breadbasket.
That raises the threat that central banks will overtighten the brakes on the economy, as they push against a string “and essentially fall into a damaging policy mistake”, Mr Rieder said.
The economy has already shown some mixed signals, and a report on Friday indicated consumer sentiment is worsening more than economists expected.
That adds to several recent profit warnings from retailers indicating US shoppers are slowing or at least changing their spending because of inflation. Such spending is the heart of the US economy.
The two-year Treasury yield zoomed to 3.05 per cent following the inflation report from 2.83 per cent late Thursday, a big move for the bond market. During the day, it touched its highest level since George W Bush's presidency, according to data from Tradeweb.
The 10-year yield was also up, but not quite as much as the two-year yield, which is more influenced by expectations for Fed movements. The 10-year yield climbed to 3.15 per cent from 3.04 per cent and touched its highest level since 2018.
The narrowing gap between those two yields is a signal that investors in the bond market are more concerned about economic growth. Usually, the gap is wide, with 10-year yields higher because they require investors lock away their dollars for longer.
A two-year yield higher than the 10-year yield would be a signal to some investors that a recession may hit in a year or two.
“This market is to some degree in this no-man’s land, where you don’t have a really good definite signal that says get constructive and buy the market, but you don’t have solid information about a recession being more likely in order to get more defensive,” said Jason Pride, chief investment officer of private wealth at Glenmede.
Friday's losses were widespread for the S&P 500, with more than 90 per cent of stocks in the index dropping.
Big Tech stocks were some of the heaviest weights amid broad losses for the biggest winners of the prior ultralow-rate era. Microsoft fell 4.5 per cent, Amazon dropped 5.6 per cent and Nvidia sank 6 per cent.
Companies that depend on strong spending from consumers were also particularly weak following the reading on consumer sentiment. Caesars Entertainment fell 9.3 per cent, and cruise operator Royal Caribbean dropped 7.3 per cent.
Stocks fell in Europe for a second day after the European Central Bank said it would raise interest rates for the first time in more than a decade to combat inflation.