A turn in the market has eroded the sharp rally at the start of the year, as investors have fretted about recent signals suggesting a resurgence in inflation.
Stocks slumped Friday on their way to their worst week of the year, as investors balked at fresh government data that added to a flurry of signals showing a resurgence in inflation.
The S&P 500 fell by around 1.3 percent in midday trading, setting the stock index up for a third straight week of declines and its worst weekly performance of the year, a decline of more than 3 percent.
That came in a shortened week, with markets closed on Monday for the Presidents’ Day holiday. Tuesday’s trading notched the worst single day for the S&P 500 since mid-December.
The turn in the market this month has come alongside a sharp reassessment among investors about what the Federal Reserve will have to do to lower inflation, and the damage that might inflict on companies, consumers and the economy.
Stock markets had rallied through January as investors pinned their hopes on a potential pause to the Fed’s rate increases, after a sustained period of slowing inflation at the end of last year.
But that hope has been undone in recent weeks by data showing employers have kept hiring, consumers have kept spending and inflation has been re-accelerating. On Friday, the latest reading of the Personal Consumption Expenditures price index, which the Fed tracks closely, showed inflation accelerating faster than expected in January.
“I think the market reaction we are seeing very clearly suggests investors think that the Fed has more work to do,” Liz Ann Sonders, chief investment strategist at Charles Schwab, said.
The Fed has been raising interest rates for almost a year, as it seeks to slow the economy and temper inflation. But higher interest rates also raise costs for companies, which typically weighs on stock prices.
Investors have ratcheted up their forecasts for how many times the Fed will raise interest rates, this week cementing expectations for three quarter-point rate increases at the central bank’s next three meetings. At the start of the month, investors expected just one more increase, at the meeting in March. They have even started to seriously price in the possibility that the Fed could go with a bigger increase in March, of half a point.
In response, bond yields have soared, with the two-year Treasury yield, a gauge of government borrowing costs that is sensitive to changes in Fed policy, reaching a post-pandemic peak on Friday. The yield rose more than a tenth of a percentage point, to 4.82 percent, its highest since 2007. That was a big move for an asset that usually rises and falls by hundredths of a point each day.