Investors flinched after the release of government data on Tuesday that upended the trend of falling inflation and signaled that the Federal Reserve’s campaign to rein in rising prices is far from complete.
After a choppy morning trade, as investors digested the latest data on inflation, the S&P 500 fell to a loss of 0.5 percent for the day. U.S. government bond yields rose, reflecting expectations for higher interest rates as the Fed attempts to bring inflation back under control.
Investors had taken solace in recent months from a consistent slowing in inflation, helping push the benchmark U.S. stock index up more than 6 percent in January. The prospect of a continued drop in the pace of price rises boosted hopes that the Federal Reserve would soon end its persistent interest rate increases, which have helped reduce inflation but have also raised costs for consumers and companies by making it more expensive to use credit cards or take out business loans.
Such exuberance had come under pressure in recent weeks, with the S&P 500 inching just 1.4 percent higher this month, ahead of the latest release of the Consumer Price Index on Tuesday. The data for January showed price increases accelerating on a monthly basis, although the year-over-year numbers continued to show a slight easing.
“This idea that we can get continued disinflation without a material slowdown in the economy has been the narrative the market has run with,” said Priya Misra, an interest rate strategist at TD Securities. “But that has come under pressure, and today reinforced it.”
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The decline of the stock and bond markets this year has been painful, and it remains difficult to predict what is in store for the future.
Already, a robust jobs market, rising used-car prices and upward revisions to past inflation numbers had complicated the picture for investors.
At the same time, policymakers have reignited expectations that the Fed would continue raising interest rates until the middle of the year, pushing up U.S. government bond yields and weighing on stock prices.
The yield on the two-year Treasury bond nudged above 4.6 percent on Tuesday, reaching its highest level of the year. The yield, which is sensitive to changes in Fed policy, had already risen roughly 0.25 percentage points this month ahead of the numbers — equal to the size of a typical rate increase from the central bank.
And the persistent weakening of the U.S. dollar, when compared with a basket of currencies representing its major trading partners, had paused. On Tuesday, the dollar rallied back from earlier losses after the fresh inflation data came out.
Bond investors had already begun to recalibrate their expectations for the number of interest rate increases to come from the Fed.
At the start of February, futures markets, which allow investors to bet on the path of interest rates, suggested a consensus view that the Fed would make just one more quarter-point increase in rates, in March. That has since risen to decent odds that there will be three increases of that size though July of this year, which would take the Fed’s target rate to a range of 5.25 to 5.5 percent, above the Fed’s own forecasts published in December.
It marks a stark turnaround from the market’s skepticism of the Fed’s forecasts as recently as just a few weeks ago.
“If you ask 10 people what they think inflation will do, you will get 12 opinions with cogent arguments back,” said Jim Sarni, a managing director at the asset manager Payden & Rygel, who maintains that inflation may have peaked even if the pace of its moderation slows and there are occasional monthly “blips.”
Such mixed signals in the market this year reflect that uncertain outlook noted by Mr. Sarni. Inflation is falling and the economy remains robust, raising hopes among investors that a severe downturn will be avoided. Yet inflation remains high, and corners of the economy are proving resilient to the Fed’s actions, raising the risk that the central bank will have to do even more to slow the economy.
“Last year, we had too much pessimism, but right now, we have a market that has got ahead of itself and is a little too optimistic,” Mr. Sarni said. “Markets are vulnerable in the short run for that reason.”
Joe Rennison
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