Worst Day Of The Year

By Nicholas Jasinski  |  Tuesday, September 13

Ouch. This morning's inflation report was not what the bulls and the doves were looking for. It prompted the worst one-day selloff for major stock indexes since June of 2020, during the volatile early months of the Covid-19 pandemic.

The Consumer Price Index rose 0.1% in August, while economists had been expecting a decline of 0.1% on average. That gain in the index last month came despite a nearly 11% drop in gasoline prices, and a 5% decrease in energy costs overall. It means prices elsewhere rose rapidly enough to overcome those declines. Food prices were up 0.8% in August, down from a 1.1% increase in July.

Excluding food and energy costs, the so-called core CPI increased by 0.6% in August, handily topping the consensus forecast for a 0.3% rise. That was also double the pace of core inflation in July.

Shelter costs rose 0.7% in August, new vehicle prices rose 0.8%, apparel rose 0.2%, and medical care services rose 0.8%. All of those accelerated from July. Inflation in gas prices may have reversed, but it's being felt in a broader range of categories and the trend isn't in the right direction for many.

The headline CPI was 8.3% higher in August than a year earlier, versus an 8.5% annual pace of inflation in July. The core CPI rose 6.3% year over year in August, versus July's 5.9% pace.

The hotter-than-expected inflation numbers reminded investors that the Federal Reserve still has its work cut out for it. That was felt in stock, bond, and futures markets.

The yield on the 2-year U.S. Treasury note spiked 0.18 percentage point, to 3.75%, today. That's up more than 3 percentage points since the start of 2022 and its highest yield since November 2007. It reflects the market's expectation of the near-term path of interest rates. 

With the federal funds target range currently at 2.25% to 2.50%, the Fed clearly has some catching up to do. 

Interest-rate futures quickly moved today to price in a larger rate increase at next week's Federal Open Market Committee meeting. Pricing now implies a 68% likelihood of a 0.75 percentage point hike and 32% of a full percentage point. A month ago, pricing implied about even odds of a 0.5 or 0.75 percentage point increase. Futures tied to later FOMC meetings also uniformly moved higher today.

All that has by-now well discussed implications for corporate earnings and stock valuations. Higher interest rates drag on the economy, raising recession odds and negatively impacting earnings growth. A stronger U.S. Dollar thanks to higher rates (the U.S. Dollar Index, or DXY, jumped 1.5% today) makes multinational corporations' foreign earnings worth less when translated back to dollars. And a higher discount rate means a lower multiple assigned to those earnings.

Coming off a four-day rally, stocks tanked today. The S&P 500 dropped 4.3%, the Dow Jones Industrial Average and Russell 2000 lost 3.9%, and the Nasdaq Composite shed 5.2% of its value.

Still, August's CPI is a backward-looking indicator, reflecting price increases that have already happened. More important, argue the doves, is what Americans expect future inflation to be.

The New York Fed's monthly Survey of Consumer Expectations showed meaningful improvement this week on that front. The median expectation for one-year inflation fell to 6.2% in August, from 5.7% in July. The median three-year inflation expectation fell to 2.8%—its lowest since early 2021—from 3.2%. And the median five-year figure hit 2.0%—equivalent to the Fed's target—from 2.3% a month earlier.

"We believe that it is the pump price of gasoline prominently posted daily at every service station in America that has the most immediate and largest impact on inflationary expectations," wrote Ed Yardeni, president of Yardeni Research, yesterday. "Gas prices soared earlier this year, and so did inflationary expectations, then both fell sharply during July and August."

That's one potential silver lining that was hardly felt by investors today.

DJIA: -3.94% to 31,104.97
S&P 500: -4.32% to 3,932.69
Nasdaq: -5.16% to 11,633.57

The Hot Stock: Corteva +0.9%
The Biggest Loser: Eastman Chemical -11.3%  

Best Sector: Utilities -2.7%
Worst Sector: Communication Services -5.5%