Traders on the New York Stock Exchange floor on Tuesday. The stock market fell the most since June 2020, with the Dow losing more than 1,250 points. Photo / AP
Hopes that the Federal Reserve can engineer a soft landing for the US economy took a hit today when a crucial measure of inflation came in higher than forecast and triggered a sharp sell-off on Wall Street.
The consumer price index increased 0.1 per cent for August, above economists' expectations for a 0.1 per cent drop.
Most worryingly for policymakers, core inflation — which strips out volatile items like energy and food — rose by 0.6 per cent for an annual increase of 6.3 per cent, compared with 5.9 per cent recorded for July.
The figures from the Bureau of Labor Statistics brought an end to a brief respite for Fed officials after July's reading showed that prices had not risen compared with the prior month.
Wall Street was caught off guard by the hotter-than-expected inflation figures.
The S&P 500 closed down 4.3 per cent, the worst performance since June 2020. The Nasdaq Composite, which is stacked with technology companies that are more sensitive to changes in interest rate expectations, ended Tuesday more than 5 per cent lower.
In government debt markets, the yield on the two-year US Treasury, which is more sensitive to interest rate expectations, surged by roughly 0.2 percentage points at 3.75 per cent, having traded at 3.52 per cent before the release of the inflation data.
The odds the Federal Reserve would opt for a full percentage point rate rise in September rose to roughly 30 per cent, according to CME Group, versus 0 per cent at the start of the week.
Most economists are forecasting another 0.75 percentage point rate rise, which would lift the fed funds rate to a new target range of 3 per cent to 3.25 per cent.
Steven Blitz, chief US economist at TS Lombard, said Tuesday's data combined with rising wages and a tight labour market meant the Fed was "not going to produce the soft-landing fairy tale".
He added: "The Fed has better odds of rolling a hard eight than engineering a soft landing."
"We don't really see anything in here that would make the Fed want to opt for a slower pace of rate hikes this month," said Brian Coulton, chief economist at Fitch Ratings.
US president Joe Biden and his economic advisers had also been hoping for a reduction in the headline figure, going so far as to schedule a "celebration" of his recently passed Inflation Reduction Act, a package of healthcare and climate policies.
"Today offers proof that the soul of America is vibrant. The future of America is bright and the promise of America is real," Biden said at the event on Tuesday. He later noted that petrol prices had dropped over the summer: "We're making progress."
Although the event was scheduled to trumpet the passage of the bill, the optics were quickly seized on by Biden's opponents in the Republican party.
"You can't make it up: Hours after this terrible inflation report, the White House is hosting an 'inflation reduction' celebration," Mitch McConnell, the Senate minority leader, wrote on Twitter.
"Democrats have spent our economy into disaster and now they're partying while families pay. They could not look more out of touch if they tried."
The jump in inflation came despite petrol prices tumbling in recent months. Earlier this summer, they topped a record $5 a gallon following a jump in oil prices after Russia's invasion of Ukraine.
The current national average is $3.70, according to the American Automobile Association.
In recent weeks, Fed policymakers have reaffirmed their commitment to bringing inflation under control and warned of the risks associated with allowing price pressures to persist.
Failing to bring down inflation, and allowing expectations of future price increases to spiral, was likely to mean more economic pain later on, chair Jay Powell and vice-chair Lael Brainard said last week.
Policymakers worry the downward trend in petrol prices is unsustainable — especially if energy prices jump later this year.
Treasury secretary Janet Yellen warned of that possibility over the weekend, citing concerns about a widespread shortage across Europe as the bloc stops buying oil from Russia.
Wall Street suffered the worst sell-off since the early days of the pandemic after official data showed US inflation increased unexpectedly in August, raising the spectre the Federal Reserve will need to act more aggressively to combat rising prices.
The benchmark S&P 500 stock index tumbled 4.3 per cent, its worst day since June 2020 with 99 per cent of its companies sliding in value. The Nasdaq Composite fell 5.2 per cent as technology groups seen as most exposed to higher rates bore the brunt of the selling.
The yield on short-dated government debt that tracks interest rate expectations hit its highest level in almost 15 years, as investors increased their bets that the Fed will have to do more to stamp out soaring inflation.
Investors on Tuesday priced in a 1-in-3 chance that the US central bank will raise rates by a full percentage point this month, according to data from CME Group rather than a 0.75 percentage point increase that remains the consensus expectation.
The inflation figures heaped further pressure on policymakers at the US central bank, who have promised to do everything in their power to curtail spiralling prices. Their apparent determination to follow through on the pledge has sparked fears the economy is heading for a hard landing.
Tech stocks are particularly sensitive to changes in interest rate expectations because the valuations are based largely on future growth prospects. Facebook owner Meta and chipmaker Nvidia were among the biggest losers, both down 9 per cent, while Amazon shed 7 per cent.
The declines sliced US$154 billion off Apple's market valuation and $109b from Microsoft's, with both companies registering their biggest daily losses since September 2020.
The frenzied selling on Tuesday hit nearly every corner of US financial markets. At one point during the trading day, nearly 2,000 stocks trading on the New York Stock Exchange fell in value in tandem, a phenomenon normally seen at times of market stress.
Investors raced to hedge against further declines by piling into equity put option contracts that could pay out if the market continues to slide.
The sharp moves were sparked by official figures showing US consumer prices increased up 0.1 per cent in August from the previous month, compared with expectations for a fall of 0.1 per cent.
The annual rate came in at 8.3 per cent, down from 8.5 per cent in July, but higher than the 8.1 per cent Wall Street economists predicted.
Most worryingly for Fed policymakers, core consumer price growth — which strips out volatile items such as energy and food — rose from 5.9 per cent to 6.3 per cent.
Matt Peron, director of research at Janus Henderson Investors, said the data "was an unequivocal negative for equity markets".
He added: "The hotter than expected report means we will get continued pressure . . . via rate hikes. It also pushes back any 'Fed pivot' that the markets were hopeful for in the near term."
In the Treasury bond market, the two-year yield, which closely tracks interest rate expectations, rose to its highest level since October 2007, ending the day up 0.18 percentage points at 3.75 per cent.
"The most dramatic thing . . . in the Treasury market today was the move in two-year yields," said Tom di Galoma at Seaport Global Holdings. "This number put on the map clearly that the Fed is going to do [a 0.75 percentage point increase] and maybe more."
Following the report, investors in the futures market bet that the Fed's benchmark interest rate would stand at 4.17 per cent by year-end, versus expectations of 3.86 per cent before the report.
That implies a 0.75 percentage point increase in September, plus another full percentage point of increases over the course of November and December.
The prospect of higher rates prompted a jump in the dollar, leaving it up 1.4 per cent against a basket of six peers. The euro and the pound fell, shedding 1.4 per cent and 1.5 per cent respectively.
The selling cascaded into eurozone bonds, with Germany's two-year Bund yield up 0.08 percentage points to 1.37 per cent and the 10-year yield rising 0.08 percentage points to 1.72 per cent.
In Europe, the regional Stoxx 600 share gauge closed 1.5 per cent lower, having climbed 1.8 per cent in the previous session. London's FTSE 100 shed 1.2 per cent.
In Asia, China's mainland CSI 300 index rose 0.4 per cent and Hong Kong's Hang Seng slipped 0.2 per cent as markets in greater China reopened following a national holiday. Japan's Topix rose 0.3 per cent.
-By Colby Smith and James Politi in Washington, Kate Duguid and Eric Platt in New York and Ian Johnston in London. Additional reporting by Hudson Lockett in Hong Kong
The local index staged a turnaround.