Wall Street experienced its worst week since early December, with the S&P 500 falling 1.1% to end its third consecutive weekly loss. The Dow Jones Industrial Average tumbled as many as 510 points before closing down 336 points, or 1%, while the Nasdaq composite lost 1.7%.
According to reports, the stock market has been in turmoil throughout February, with data revealing that inflation, the job market, and consumer spending are all hotter than anticipated. As a result, Wall Street has had to revise its predictions for the Federal Reserve’s interest rate increases and their duration.
Although higher interest rates can combat inflation, they also raise the risk of a recession by slowing down the economy and negatively impacting stock prices and other investments. A report released on Friday showed that inflation’s preferred measure by the Federal Reserve exceeded expectations. The prices increased by 4.7% in January compared to the previous year, excluding the costs of food and energy. It was also higher than economists’ expectations of 4.3% and an acceleration from December’s inflation rate, indicating the wrong momentum.
Earlier reports from February showed that both consumer and wholesale inflation was higher than expected in January. A separate report on Friday also revealed that consumer spending rose 1.8% from December, which is a significant portion of the economy. In addition, a reading on consumer sentiment came in slightly stronger than earlier predictions, and sales of new homes were better than anticipated.
While the resilient job market and consumer spending increases raise hope that the economy can avoid a recession in the near term, it also adds to inflation’s upward pressure. Wall Street is concerned that it could prompt the Federal Reserve to raise interest rates even higher and for a longer duration.
Ross Mayfield, an investment strategy analyst at Baird, said, “It puts the final nail in the coffin in the shift we’ve seen the last several weeks where the market has come around to what the Fed has been saying for a while: rates above 5% and there for longer.”
Traders have been increasing their bets on the Federal Reserve’s rate rising to at least 5.25% and staying there through the end of the year, despite initially doubting the Fed’s predictions. The key overnight rate, currently ranging from 4.50% to 4.75%, was virtually zero a year ago.
High inflation and interest rates increase the risk of a recession, even if the economy’s most crucial component remains strong. Mayfield expects the economy’s growth to fall below its long-term trend or even experience a minor recession, although he does not anticipate a worst-case scenario downturn.
Expectations for a firmer Federal Reserve have caused yields in the Treasury market to rise higher this month. They climbed further on Friday, with the yield on the 10-year Treasury rising to 3.94% from 3.89% late Thursday. The two-year yield, which moves more on expectations for the Fed, rose to 4.79% from 4.71% and is near its highest level since 2007.