Stocks Sink as Stubborn Inflation Resets Fed Rate Forecasts

Stock markets tumbled on Tuesday as investors slashed their bets on the Federal Reserve taking the brakes off the economy in the coming months, after hotter-than-expected inflation data led traders to expect interest rates will remain higher for longer.

The benchmark S&P 500 stock index fell 1.8 percent, putting it on course for its worst one day drop since the banking crisis in March last year. The index has suffered only one other loss greater than 1 percent this year, with bullishness about the resilience of the economy and corporate profits continually pushing stocks to new highs.

Investors still expect the Fed to pull inflation back to manageable levels without inflicting too much pain on the broader economy. But that forecast was put under pressure on Tuesday by a consumer inflation report that showed prices had been rising more quickly than what had been forecast.

The consumer data “came in stronger than either the Fed or the market wanted or expected,” said Greg Wilensky, head of U.S. fixed income at Janus Henderson Investors.

The longer inflation remains elevated, the longer the Fed is likely to push off rate cuts, turning the screws on an economy that is already starting to show some signs of weakness, and tempering enthusiasm on Wall Street.

The two-year Treasury yield, which is sensitive to changes in investors’ interest rate expectations, jumped nearly 0.2 percentage points, to around 4.65 percent, the biggest move higher in that market since March.