Stocks end lower as Wall Street braces for big rate hike

Stocks ended another shaky day on Wall Street with more losses on Wednesday, after a much-anticipated inflation report turned out to be even worse than expected.

The S&P 500 ended down 0.4%, its fourth consecutive decline, after falling 1.6% earlier. The Dow Jones Industrial Average fell 0.7%, while the Nasdaq composite fell 0.2%, erasing most of an early 2.1% loss.

Markets made a few U-turns in the morning, as has become the norm on Wall Street this tumultuous year. They were following the lead of Treasury yields in the bond market, which initially jumped on expectations that Federal Reserve policymakers would dramatically raise interest rates to slow the nation’s runaway inflation.

“They seem to have the green light to raise interest rates, with the labor market still in very good shape and inflation remaining well above what they want,” said Tom Hainlin, national strategist in investment at US Bank Wealth Management.

Inflation and the Federal Reserve’s response to it have been the focus of Wall Street’s sell-off this year. Discouraging data on Wednesday showed that inflation is not only still very high, but worsening.

“For four or five months now, we’ve been counting on an inflation spike and we’ve been constantly disappointed,” said John Lynch, chief investment officer at Comerica Wealth Management.

Consumer prices were 9.1% higher last month than a year earlier, accelerating from the 8.6% inflation level in May. It was also worse than economists’ expectations for 8.8%.

The Fed’s main tool to fight inflation is to raise short-term interest rates, which it has already done three times this year. After Wednesday’s inflation report, traders now see it as a lock that the Federal Reserve will raise its key interest rate by at least three-quarters of a percentage point at its next meeting in two weeks.

That would match its most recent hike, which was the biggest since 1994. A growing number of traders are even suggesting the Fed will go for a monstrous hike of a full percentage point.

The latest inflation data “certainly creates more certainty that the Fed is going to be quite aggressive at the July meeting,” Hainlin said.

Traders are betting on a 67.8% chance of a full point rise, up from zero a month ago, according to CME Group.

The risk is that rate hikes are a notoriously blunt tool, one that takes a long time for the full effects to be felt. If the Fed ends up being too aggressive with them, it could cause a recession. In the meantime, higher rates drive down the prices of all kinds of investments.

“The shock and fear from the Fed could do a lot of collateral damage to the economy without much relief to near-term inflation,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments.

“The Fed probably needs to temper people’s expectations of what they can do,” he said.

In total, the S&P 500 fell 17.02 points to 3,801.78. The Dow lost 208.54 points to 30,772.79 and the Nasdaq lost 17.15 points to 11,247.58.

Small company stocks also lost ground. The Russell 2000 slipped 2.15 points, or 0.1%, to 1,726.04.

In the bond market, the two-year Treasury yield rose to 3.13% from 3.05% on Tuesday evening. It tends to track expectations for Fed action, and hit 3.22% immediately after the inflation report was released.

It remains above the 10-year yield, which fell to 2.91% from 2.95% on Tuesday evening. It’s a relatively rare event, and some investors see it as a worrying signal of a potential recession.

The inflation data also sent immediate jolts to stock markets across Europe and to gold, with prices for each weakening after the report was released. US gold for August delivery ended up 0.6% higher.

Even with the swings, Wall Street’s reaction has been more subdued than it was after the last inflation report. A month ago, the reading of the consumer price index, or CPI, showed an unexpected acceleration in inflation. This dashed some hopes that inflation was peaking and sent the S&P 500 down 2.9%.

Since then, parts of the economy have already slowed due to inflation and the Fed’s actions to combat it, particularly the housing market. Oil and other commodity prices also fell as fears of a recession lowered demand expectations.

“While some will draw parallels to May’s shockingly bad CPI report, the context is markedly different – commodity prices have fallen sharply and we have seen clearer signs of an economic slowdown, all of which will help two to lower price pressures,” said Michael Pearce, senior U.S. economist at Capital Economics.

Or, as the Chief Investment Officer of Global Fixed Income at BlackRock puts it: “high prices are the cure for high prices.” High inflation is pushing households and businesses to cut spending, and reduced demand should ultimately help bring inflation down, Rick Rieder wrote in a report.

In addition to interest rates, which affect how much investors are willing to pay for stocks, investors are also getting updates this week on the other big factor that sets prices on Wall Street: profits earned by businesses.

Delta Air Lines fell 5% after reporting weaker spring earnings than analysts expected. High jet fuel prices and a series of canceled flights in May and June weighed on its results.

The big banks and financial firms come next, as the reporting season begins for profits made from April to June.

Banks and other financial firms were among the market’s worst performers on Wednesday, dragged down by worries about the economy. They are also affected when short-term interest rates are higher than long-term rates, disrupting their business of borrowing at short-term rates and lending at long-term rates to profit from the difference.

JPMorgan Chase, which reported Thursday, fell 0.9%. Citigroup, which reported Friday, fell 1.4%.

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AP Business Writer Joe McDonald contributed.