Concerns about inflation making a comeback gave investors a scare Wednesday, raising alarms about the bull run in stocks and whether the Federal Reserve already cut rates too much.
The consumer-price index for January showed surprisingly strong inflation pressures to start 2025, instead of making further progress toward the Fed’s 2% annual target.
“I think there’s probably some residual hope in the market for a September rate cut,” said Matt Stucky, chief portfolio manager, equities, at Northwestern Mutual Wealth Management Co. “I think that’s completely off the table after today’s number.”
Traders have been dialing back expectations for Fed rate cuts this year, with the odds on Wednesday favoring only a single 25-basis-point cut by December, according to the CME’s FedWatch Tool.
While the fresh inflation reading represents only one print, it casts further doubt on whether the Fed has any more room to cut rates at all. It also resurfaced talk about whether a rate hike might be in the cards.
“Today’s CPI print adds to the evidence that monetary policy is not as restrictive as the Fed thinks it is, or wants it to be,” Jeff Hibbeler, director of portfolio management at Exencial Wealth Advisors, wrote in emailed comments.
“The Fed’s front-loading of 100bps of cuts last fall, led by a supersize cut in September is looking more like a policy mistake, at least from the perspective of achieving their price-stability mandate.”
Stocks enter precarious period
Stocks opened sharply lower after the data, but moderated losses by midday. The blue-chip Dow DJIA+0.77% was down 192 points, or 0.4%, near 44,400, after dropping 489 points at its session low. The S&P 500 SPX+1.04% was off 0.3% and the Nasdaq Composite Index COMP+1.50% was fractionally lower, with both trimming steep opening declines.
After a bumpy start to January, stocks had enjoyed something of a honeymoon period in recent weeks as President Donald Trump fired off a raft of executive orders to make his desire to cut immigration and tariff threats clearly known.
Relative calm in the bond market in the first few weeks of Trump’s second term was a big help for stocks, with the all-important 10-year Treasury yield TMUBMUSD10Y 4.535% lately holding steady around the 4.5% range, a level viewed as tolerable for stocks as they attempted to reclaim record territory.
That was until Wednesday, when the 10-year Treasury yield has shot up about 10 basis points to 4.64%,
That threatens to keep upward pressure on borrowing costs for households and the U.S. government, as well as the hotter-than-expected CPI report landing at a precarious time for stocks.
Ryan Detrick, chief market strategist at Carson Group, points out that the first quarter following an election year tends to be among the weakest of the entire four-year cycle, when looking at data going back to 1950.
He also notes the second-half of February tends to be when things start to unravel for stocks.
To be sure, the stock market’s trend data since 1950 includes the abysmal performance of the S&P 500 index SPX+1.04% in the first quarter of 2009, in the wake of the global financial crisis.
But the historical pattern remains worthwhile to keep in mind as investors grapple with Trump’s on-off tariff tactics and try to gauge what they could mean for the overall inflation outlook.
Consumers’ inflation expectations also have risen, included in the flash reading of the University of Michigan’s consumer-sentiment survey, released Friday. Chair Jerome Powell said this week that inflation expectations remain well-anchored. But in the past, he has warned that, if they come unglued, it could make the Fed’s inflation-fighting mission that much more difficult.
That backdrop has even stalwart stock-market bulls like Global X’s Scott Helfstein sounding cautious.
“This is a tough inflation report to get while the White House is looking at further tariffs with consumer inflation expectations jumping higher. While this does not blunt our optimism yet on both the economy and stocks, it does bear watching closely,” Helfstein said in emailed comments.
10-year Treasury yield watch
The sharp rise in 10-year Treasury yields on Wednesday implied that investors in the bond market were brushing aside Treasury Secretary Scott Bessent’s recent comments about the Trump administration being more focused on bringing down long bond yields than it is on short-term interest rates controlled by the Fed.
Trump, again on Wednesday, insisted in a post on Truth Social that interest rates should be lowered.
Regardless, market forces ultimately control bond yields. And at this point, investors said it isn’t inconceivable that the 10-year Treasury yield could top 5% later this year.
That would likely mean even more pain ahead for stocks.