A Double-Edged Sword-Banner

HIGHLIGHTS:

• Stocks had their worst day since June 2020 on Tuesday following the release of last month’s inflation print.
• The Consumer Price Index declined to a pace of 8.3 percent in August, higher than the expected 8.1 percent.
• Officials will likely shift to an even more assertive stance, which may increase the chances of a hard landing.
• Select economic data has been strangely positive amid all the pessimism, which may turn out to be a double-edged sword.

Stocks bounced back in early trading this morning and pared losses after a tumultuous Tuesday. Yesterday, a broad-based selloff sent shares lower, with the S&P 500 losing 4.3 percent, led by consumer-focused sectors. The Dow Jones Industrial Average fell 1,276 points, or 3.9 percent. The declines were the worst one-day move in stocks since June 2020. Most assets lost value, and bonds were not spared from the selloff either. Treasury yields jumped upward, with the benchmark 10-year climbing to 3.4 percent. Most of these price reactions occurred directly after the August Consumer Price Index release, which showed inflation declined to a pace of 8.3 percent—below the prior month’s rate but above the expectations of 8.1 percent. On the surface, this might seem like a reaction—over overreaction—to another red-hot inflation print. However, what’s really happening is investors are looking to see how this will affect policymakers’ plans.

Officials at the Federal Reserve had recently stated that they would be unrelenting in their pursuit of reducing inflation, even at the cost of some economic losses and “pain” to the consumer. This latest inflation reading has all but cemented an even more aggressive Fed and raised bets for a 0.75 percent rate increase at its meeting next week. A history-making, full-percent move could also be on the table. Market expectations have shifted dramatically, with fed funds futures showing investors are betting on larger increases from the Fed that would result in the key overnight rate reaching around 4.2 percent by the end of this year. Despite some forecasts for potential cuts next year, officials have been adamant that rates would be kept high, likely through most of 2023. Higher rates for longer will very likely increase the chances of a hard landing in the future.

While inflation continues to dominate the conversation, there is quite a bit of other news for investors to digest. The economy has retained unexpected momentum, most notably within buoyant consumer spending and a tight labor market. Though, a growing number of corporations have announced hiring and staff reductions. It’s safe to say that some specific economic data has been strangely positive amid all the pessimism. However, that may turn out to be a double-edged sword as Fed officials become increasingly forceful in response. For now, it seems cooler heads have prevailed in the markets, and investors will anxiously await the Fed’s meeting next week.

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