NEW YORK – The Dow Jones Industrial Average sank more than 1,000 points Tuesday as the market shuddered following Wall Street’s realization that inflation is not slowing as much as expected.
The sell-off knocked the benchmark S&P 500 down 3.7% in afternoon trading, threatening to snap a four-day winning streak. Bond prices also fell sharply, sending their yields higher, after the report showed inflation only dropped to 8.3% in Augustinstead of 8.1% economists expected.
The hotter-than-expected reading has traders on the lookout for the Federal Reserve eventually raising interest rates even higher than expected. fight inflation, with all the risks for the economy that is necessary. Fears about higher rates have driven prices down for everything from gold to cryptocurrencies to crude oil.
“Today, it’s not so much the journey that worries us as the destination,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments. “If the Fed wants to hike and hold, the big question is at what rate.”
The Dow lost 1,105 points, or 3.4%, to 31,274, as of 3:08 p.m. Eastern time, and the Nasdaq composite was down 4.6%. Big tech stocks outperformed the rest of the market, as all 11 sectors that make up the S&P 500 sank.
Most of Wall Street came into the day thinking that the Fed would raise key short-term rates by three-quarters of a percentage point at next week’s meeting. But the hope is that inflation is in the midst of quickly falling back to a more normal level after the June peak at 9.1%.
The thinking is that such a slowdown will allow the Fed to reduce the size of its rate hikes until the end of this year and then potentially hold steady until early 2023.
Tuesday’s report dashed some of those hopes. Many of the data points in it were worse than economists expected, including some the Fed paid particular attention to, such as inflation outside of food and energy prices.
The market honed in on the rise of 0.6% in such prices during August from July, double what economists expected, said Gargi Chaudhuri, head of investment strategy at iShares.
The inflation figure was worse than expected as traders now see a one-in-five chance of a full percentage rate hike by the Fed next week. That would be quadruple the usual move, and no one in the futures market was predicting such an increase the day before.
Traders now see a better than 60% chance the Fed will pull its federal funds rate down to a range of 4.25% to 4.50% by March. A day earlier, they saw less than a 17% chance of a high, according to CME Group.
The Fed has raised benchmark interest rates four times this year, with the last two increases by three-quarters of a percentage point. The federal funds rate is currently in the range of 2.25% to 2.50%.
“The Fed cannot let inflation stay. You have to do whatever it takes to stop prices from rising,” said Russell Evans, managing principal at Avitas Wealth Management. “This shows that the Fed still has a lot of work to do to reduce inflation.”
Higher rates hurt the economy by making it more expensive to buy a home, car or anything else bought on credit. Mortgage rates have hit their highest level since 2008, creating pain for the housing industry. The hope is that the Fed can pull the trigger that slows the economy enough to eliminate high inflation, but not enough to create a painful recession.
Tuesday’s data put hopes of such a “soft landing” under more threat. Meanwhile, higher rates also boost the prices of stocks, bonds and other investments.
Investments that are considered the most expensive or riskiest are the ones that will be hit the hardest by higher rates. Bitcoin tumbled 7.1%.
In the stock market, all but four of the stocks in the S&P 500 fell. Technology and other high-growth companies fell more than other markets because they were seen as riskiest from higher levels.
Apple, Microsoft and Amazon are all down more than 4% and are the market’s heaviest weights. The communications services sector, which includes parent company Google and other internet and media companies, fell 4.8% for the biggest loss of the 11 sectors that make up the S&P 500 index.
To be sure, the losses only returned the S&P 500 to near where it was before its winning streak. The run was built on the hope that Tuesday’s inflation report would show a better slowdown. The ensuing wipeout fits what has become a pattern on Wall Street this year: Stocks fall on worries about inflation, turn higher on hopes that the Fed can ease up on rates and then fall again when the data undercuts those hopes.
Tuesday’s inflation report arrived before trading began on Wall Street, but sent a thud through markets around the world.
Treasury yields leaped immediately on expectations for a more aggressive Fed. The yield on the two-year Treasury, which tends to track expectations for Fed action, rose to 3.76% from 3.57% late Monday. The 10-year yield, which helps dictate where mortgage and other lending rates go, rose to 3.42% from 3.36%.
Stock markets in Europe, meanwhile, pared early gains and closed broadly lower. Germany’s DAX lost 1.6%, and France’s CAC 40 fell 1.4%.
Expectations for a more aggressive Fed also helped the dollar add to its already strong gains for the year. The dollar has been surging against the euro, the Japanese yen and other currencies in large part because the Fed has hiked rates quickly and with large margins from many other central banks.
An index that measures the value of the dollar against several major currencies rose 1.4%.
AP Business Writer Damian J. Troise contributed.