Although persistently rising inflation has been a cloud hanging over the stock market for the last several months, some investors had begun to believe that the worst of it was behind them. They pointed to a few indicators suggesting inflation was beginning to moderate and expressed optimism that officials could reign in price hikes without bringing the economy to its knees.
This perception was shattered by a report that was released on Friday. The research revealed that inflation re-accelerated in the previous month, with consumer prices climbing 8.6 percent from a year earlier.
Following the publication of the report by the Labor Department, the S&P 500 experienced a decline of 2.9 percent, which contributed to the index’s weekly loss of just over 5 percent. This was the index’s worst weekly performance since January, and it was also the ninth weekly decline in the previous 10 weeks. The values of government bonds fell as well due to the widespread belief that the Federal Reserve may have to hike interest rates more quickly than first anticipated in order to bring inflation under control.
The issue that is foremost on the minds of investors is the potential impact that a sharp increase in interest rates may have on the economy. The Federal Reserve might unintentionally set off an economic downturn and drag the market down with it if it raises interest rates to levels high enough to manage inflation.
Since March, the central bank has implemented two rate hikes, bringing its benchmark rate up from near zero to its present level. Since then, investors and analysts have been debating whether the central bank would begin to slow the pace of its rate hikes. According to Ian Shepherdson, the head U.S. economist at Pantheon Macroeconomics, the inflation report that was released on Friday “kills any remaining vestiges of optimism that the Fed may pivot” to a more gradual pace of hike at its meeting the following week.
Speculators now see a decent chance that the Federal Reserve’s key rate could rise by 1.75 percentage points by September, to a target range of between 2.5 percent and 2.75 percent, up from its current target of between 0.75 percent and 1 percent. This would imply a supersize series of increases that have not been seen in decades.
Mr. Shepherdson said that there was still a distinct possibility that the data from May was somewhat of an anomaly and that subsequent readings will be somewhat more mild. According to him, this would provide the Federal Reserve the ability to increase interest rates at a more measured pace beginning with the meeting it holds in September.
According to Mr. Yardeni, trading in the bond market indicated that investors anticipate the Fed to raise interest rates aggressively over the next year before a significant slowdown in the economy begins to lower inflation. This expectation is supported by the fact that rates on short-term government bonds rose more quickly on Friday than those on longer-term bonds.
On Friday, the yield on two-year Treasury notes climbed to 3.06 percent, which is an increase of about one quarter of a point, while the yield on 10-year Treasury notes rose to 3.16 percent, which is an increase of approximately one tenth of a point.
When it comes down to it, investors are concerned about the impact that high prices and growing borrowing rates will have on consumer spending and the earnings of businesses. According to Yung-Yu Ma, the senior financial strategist at BMO Wealth Management in the United States, absorbing the expenses would have a negative impact on firm profitability, but passing them forward to customers might make existing issues in the economy much worse.
The current decline in the S&P 500 from its record high on January 3 is 18.7 percent. This brings the index back within striking distance of entering bear-market territory, which is defined as a decline of 20 percent from a previous peak, and indicates a significant shift in investor sentiment on Wall Street. The index briefly entered bear territory over the previous month, but it was able to rebound and finish the month slightly above a level that is psychologically important.
During an interview, Phil Orlando, the chief equities strategist at Federated Hermes, a company that specialises in asset management, said that he anticipated the market will drop even more during the course of the summer, maybe falling by ten percent from its present level. He prefers what are known as value stocks, which include firms in the energy, finance, and health care sectors, over growth stocks, which include companies in the technology industry, since value equities have lower values and greater potential in the current market situation.
In the meanwhile, since he also anticipates additional losses in the bond market, he is putting more of an emphasis on retaining cash, which, in comparison to equities and bonds, hasn’t been this advantageous for more than twenty years, he added.
In spite of the fact that the markets moved up and down in reaction to Friday’s inflation data, as they always do when they are caught off guard by figures, market experts are of the opinion that the fundamental realities for investors have not altered.