The Dow Jones Industrial Average fell 900 points, or 2.8%. The S&P 500 fell 3.2% and the Nasdaq Composite fell 4.1%. Bond prices also fell sharply, pushing their yields higher after a report showed inflation fell to 8.3% in August, from the 8.1% economists had expected. Major tech stocks swooned more than the rest of the market as all 11 sectors in the S&P 500 fell.
The disappointing data means traders are bracing for the Federal Reserve to eventually raise interest rates even higher than expected to fight inflation, with all the risks that entails for the economy.
“Right now the journey is not so much a concern as the destination,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments. “If the Fed wants to raise and hold, the big question is at what level.”
Nearly all of Wall Street thought the Fed would raise its key short-term interest rate by a hefty three-quarters of a percentage point at its meeting next week. But the hope was that inflation was in the midst of a rapid decline to more normal levels after peaking at 9.1% in June.
The thinking was that such a slowdown would allow the Fed to reduce the size of its rate hikes through the end of this year and then potentially keep it stable through early 2023.
Tuesday’s report dashed some of those hopes. Many of the data points in it were worse than economists expected, including some that the Fed is paying particular attention to, such as inflation outside of food and energy prices. Markets went in for a 0.6% rise in such prices in August from July, double what economists had expected.
“This suggests that inflation expectations may be getting ingrained,” said Gargi Chaudhuri, chief investment strategy at iShares.
Inflation data was so much worse than expected that traders now see a one in five chance of a full percentage point hike by the Fed next week. That would be four times the size of the usual move, and no one in the futures market had predicted such a rise a day earlier.
Traders now see a more than 60% chance that the Fed will raise Federal Funds interest rates all the way to a range of 4.25% to 4.50% in March. A day earlier, according to CME Group, they saw less than a 17% chance of such a high percentage.
The Fed has already raised its benchmark rate four times this year, the last two times by three-quarters of a percentage point. The Federal Funds rate is currently in a range of 2.25% to 2.50%.
Higher rates hurt the economy by making it more expensive to buy a house, car, or anything else on credit. Mortgage rates have already reached their highest level since 2008, causing pain for housing construction. The hope is that the Fed can get through the tightrope by slowing the economy enough to stamp out high inflation, but not so much that it triggers a painful recession.
Meanwhile, higher rates are also depressing the prices of stocks, bonds and other investments. Investments considered the most expensive or riskiest are hit hardest by higher rates, with bitcoin slumping 6.6%.
In the stock market, all but 16 stocks in the S&P 500 fell. Technology and other high-growth companies fell more than the rest of the market, as they are seen as the biggest risks of higher prices.
Apple, Microsoft and Amazon all fell by at least 4% and were the heaviest weights on the market. The communications services sector, which includes the parent company of Google and other internet and media companies, fell 4.5% for the biggest loss of the 11 sectors that make up the S&P 500 index.
The inflation report arrived before trading started on Wall Street, but it caused a slump in markets around the world.
Treasury yields immediately jumped higher than expectations for a more aggressive Fed. Two-year Treasury yields, which tend to follow expectations for Fed action, rose to 3.73% from 3.57% at the end of Monday. The 10-year interest rate, which partly determines where mortgages and rates for other loans go, rose from 3.36% to 3.43%.
The stock markets in Europe, meanwhile, went from gains to losses. The German DAX fell 1.2% and the French CAC 40 fell 1%.
Expectations for a more aggressive Fed also aided the dollar in its already strong gains for the year. The dollar has risen sharply against the euro, the Japanese yen and other currencies, largely because the Fed has raised interest rates faster and at wider margins than many other central banks.
An index measuring the dollar’s value against several major currencies rose 1%