U.S. stocks are experiencing a decline on Wednesday after the release of new inflation data, which revealed that prices have been increasing for the third consecutive month. This unexpected rise in prices has dampened expectations for any potential rate cuts by the Federal Reserve this year, as concerns grow that efforts to control high price levels may be losing momentum.
The S&P 500 is experiencing a significant decline in early trading, indicating one of the worst days it has had this year. As of 9:35 a.m. EST, the Dow Jones Industrial Average is down 451 points, representing a 1.2% decrease, while the Nasdaq composite has also dropped 1.1%.
Joe Davis, the chief global economist at Vanguard, remarked that there are still remnants of inflation scattered throughout the economy.
Shoppers find the situation painful as it could lead to increased prices in stores. Wall Street is also feeling the pain because it may result in the Federal Reserve hesitating to deliver the anticipated interest rate cuts that traders have been eagerly betting on.
The S&P 500 has experienced a significant surge of over 20% since Halloween, largely due to the anticipation of the Federal Reserve reducing its benchmark interest rate. Currently, this rate is at its highest point in over two decades. The potential rate cuts are expected to alleviate the strain on the economy and incentivize investors to invest more in stocks, bonds, cryptocurrencies, and other assets, leading to increased prices.
The Federal Reserve has been patiently observing for further proof that inflation is steadily declining towards its target of 2%. Despite a promising decrease last year, there is now concern that inflation may remain stagnant, as the inflation reports from January, February, and March have all exceeded expectations. This is coupled with other data indicating a similar trend in the overall economy.
The release of CPI data caused a sharp decline in various assets, including bonds, bitcoin, and gold. According to the government, the significant rise in gasoline prices and rent accounted for more than half of the monthly increase.
According to a research note by Quincy Krosby, the chief global strategist for LPL Financial, this report highlights the Fed’s ability to start an easing cycle at the June FOMC meeting. However, Krosby also acknowledges that there will be further inflation-related data releases before then, which may make it increasingly challenging for the Fed to cut rates in June.
Investors are clearly recognizing that the path ahead is becoming more intricate. Traders have significantly reduced their expectations of the Fed initiating rate cuts in June. Currently, there is only a 25% probability of this happening, compared to the previous estimate of almost 74% a month ago, as indicated by CME Group’s FedWatch tool.
Traders have notably adjusted their predictions, placing more emphasis on the possibility of the Federal Reserve reducing interest rates only twice within the current year. In contrast, their initial projections at the beginning of the year indicated expectations of six or more rate cuts extending until 2024.
According to Brian Jacobsen, chief economist at Annex Wealth Management, two data points may not be sufficient to establish a trend, but three could potentially indicate a shift in the conversation surrounding the Federal Reserve’s actions. Jacobsen suggests that if there is another reading that aligns with the current data, discussions about when to cut interest rates may be replaced with considerations about whether to increase them.
More hikes?
High interest rates have the potential to dampen inflation as they act as a brake on the economy and negatively impact investment costs. There is concern that if interest rates remain elevated for an extended period of time, it could lead to a recession.
Critics had already highlighted the overvaluation of the U.S. stock market based on various indicators. Either there had to be a decrease in interest rates or a significant improvement in company profits to bring stock prices to a more reasonable level. The optimism on Wall Street is rooted in the belief that the strong U.S. economy has the potential to support company profits, even if it dampens expectations for rate cuts.
According to Ian Shepherdson, chief economist at Pantheon Macroeconomics, he remains unconvinced that the recent CPI data, although concerning, indicates a consistent upward trend rather than just a temporary setback.
“In a recent note, he expressed optimism about the drivers of the post-COVID inflation boom, stating that they are all moving in the right direction. While acknowledging that there may be some bumps along the way, he emphasized the importance of considering short-term disappointments within the broader, positive outlook.”
According to Lydia Boussour, a senior economist at EY, she too expects the CPI numbers to soon start decreasing.
In a research note, she stated that the short-term inflation dynamics show a decline in disinflation, but there is an expectation of a resumption of downward momentum in the upcoming months. She further mentioned that although the onset of the Fed easing cycle is still anticipated to occur in June, recent data might sway a slight majority of policymakers towards a reduced number of rate cuts in 2024 and a delayed initiation of the easing cycle.
Other analysts have a strong pessimistic view regarding the possibility of rate cuts in the near future, and their skepticism is not without justification. Chair Jerome Powell and other officials, including Loretta Mester, the president of the Cleveland Fed, have emphasized that the Federal Reserve’s decision to cut rates hinges on the timing and the extent to which inflation reverts 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 is unlikely. McBride pointed out that inflation has exceeded expectations and the lack of progress towards the 2% target is becoming a trend. Additionally, with oil prices reaching a 5-month high, the headline Consumer Price Index has actually risen faster over the past year compared to February.
According to McBride, the latest inflation data raises concerns. He believes that there has been no improvement and that we are heading in the wrong direction.
Delta Air Lines and banking earnings
Big U.S. companies are taking their turns to announce their first-quarter earnings, and Delta Air Lines has made a strong start by exceeding expectations with its financial performance.
The airline expressed that it is currently witnessing a robust demand for flights across the globe, and it anticipates this strength to persist throughout the spring season. As a result, its stock experienced a 3.4% increase, while other airline stocks also saw a rise in tandem.
The spotlight in earnings season will soon be on the banking industry, as JPMorgan Chase and Wells Fargo are set to report their earnings on Friday.
Real-estate investment trusts, utility companies, and other stocks that are typically impacted negatively by high interest rates were among the major losers on Wall Street. The real-estate stocks in the S&P 500 experienced a significant decline of 3%, marking the largest loss among all 11 sectors within the index.
Indexes in Europe experienced a decline in stock markets abroad. However, there was a positive trend in Asian trading, with stocks rising by 1.9% in Hong Kong. Conversely, there was a decline of 0.7% in Shanghai following Fitch Ratings’ downward revision of China’s public finances outlook.
