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Stock investors are less than pleased with August inflation numbers.
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Core inflation rose unexpectedly, dashing hopes for a bigger rate cut from the Fed.
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Traders are now grappling with the reality that rates are staying higher for longer.
The stock market is having another outburst.
US indexes slumped on Wednesday, with the Dow dropping as much as 600 basis points in the early morning as traders took a mixed-bag of inflation data.
The consumer price index for August showed prices grew 2.5% on a yearly basis, per the Bureau of Labor Statistics. That's the lowest headline inflation rate recorded since early 2021. However, core inflation, which excludes volatile food and energy prices, came in hotter than expected, rising 0.3% for the month, ahead of the estimated 0.2% increase.
Investors are freaking out over the upside surprise. It's a sign that inflation is sticky enough to take a 50 basis-point rate cut off the table at the Fed's next policy meeting, which some investors had been eagerly pricing in.
After the CPI reading, markets see an 83% chance the Fed will cut rates just 25 basis points next week, up from 56% odds priced in a week ago, according to the CME FedWatch tool.
"Another month, another slightly awkward datapoint," Julian Howard, the chief multi-asset investment strategist at GAM Investments, said in a note, adding that core and services inflation looked "firmly unvanquished" in the latest figures.
"However, it does seem at least that a full 0.5% cut just became a little less convincing. Apart from anything else, the Fed's dual mandate means that it can't build its case for an aggressive or indeed any cut solely around a weakening labour market," he later added.
While markets may be upset about the dimmer prospects of a bigger cut, a 50 basis point move by the Fed would be a potentially doubled-edged sword. Cutting rates 50 basis points could have alarmed markets that the Fed was worried about a meaningful slowdown in the economy, analysts have noted in recent weeks. On the other hand, cutting interest rates by just 25 basis points means higher for longer interest rates.
Investors are now paying extra close attention to the job market for signs of further weakness. Jobless claims on Thursday will be the next labor market input ahead of the Fed meeting next week.
"The job market will continue to be an influencer," Gina Bolvin, the president of Bolvin Wealth Management Group, said in a statement. "Today's inflation data cemented in a 25 basis point cut next week 50 basis points in out the window," she added.