The stock market resumed a recent sell-off on Friday after the Federal Reserve’s most closely watched inflation indicator came in hotter than expected—adding to a slew of recent data points signaling prices are still rising beyond the central bank’s control, suggesting it may have to work more aggressively to slow the economy down.
The Dow Jones Industrial Average slipped 392 points or 1.2% by 9:45 a.m. ET on Monday, while the S&P 500 and tech-heavy Nasdaq fell 1.3% and 1.7%, respectively—pushing each major index down about 3% for the week.
The early morning sell-off intensified after the Commerce Department reported the prices consumers paid for goods and services last month edged up 5.4% from a year ago—up from 5.3% one month prior and above expectations calling for a decline to 5%, according to the personal consumption expenditures price index.
The index, which Fed officials use to inform policy decisions, adds to a streak of hot January data that started at the beginning of this month, with a blowout jobs report that far exceeded economist projections—and fueled expectations that the Fed will have to hike rates more aggressively to slow the economy and ease inflation.
Stocks have struggled since, with the S&P falling nearly 5%, and driving concerns on Friday, the core-PCE index, which excludes volatile food and energy prices, jumped 0.6% on a monthly basis in January—more than the 0.5% forecast and marking the first increase since October.
“The Fed has much more work to do,” Chris Zaccarelli of Independent Advisor Alliance said after the report, adding he has been “exercising much more caution” as the data “reinforces the view that inflation is more persistent” and could become entrenched, making it “extremely unlikely” officials will cut rates this year.
Though the PCE report showed consumer spending is still strong, Morgan Stanley analysts earlier this week cautioned it’s only a matter of time before the broader economy starts feeling the sting of higher rates, noting the impact of rate hikes could take up to two years to ripple across markets and telling clients, “The damage is done, and the fallout is likely still ahead of us.”
After hitting a near two-year low in October, stocks rallied as signs inflation was slowing started to abound, but this month has shown the journey to normal price levels may be much longer than many hope. Though it’s unclear when the Fed will stop raising rates, analysts at Goldman and Bank of America added another rate hike to their forecasts following a hotter-than-expected inflation reading last week. They now expect the central bank will raise rates to a top level of 5.5%, potentially hitting the highest level in more than 20 years.
“The big upside surprise from inflation… makes the Fed more likely to keep interest rates higher for longer, meaning more restraint on interest rate sensitive parts of the economy later this year and into early 2024,” says Comerica Bank chief economist Bill Adams. Rate-sensitive areas include the housing market and technology stocks.
What To Watch For
With hiring set to “slow meaningfully” and rising uncertainty likely to dampen households’ willingness to spend as the Fed’s hikes slow the economy, EY Parthenon senior economist Lydia Boussour expects consumer spending will be soft in the first half of the year. “These dynamics will be exacerbated by negative wealth effects from lower stock prices and declining home values,” she notes, adding consumers have already made a “large dent” in excess savings accumulated during the pandemic and that data from the New York Fed shows a “concerning rise in the number of households transitioning into delinquency status.”