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14 Sep
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Markets plunge on higher-than-expected inflation numbers.

Stocks plummeted, U.S. government bond yields rocketed higher, and the dollar bounced, after fresh inflation data undermined investors’ bets over the slowing pace of inflation in August.

The S&P 500 slumped 4.3 percent on Tuesday, its biggest drop since the depths of the coronavirus pandemic in June 2020. Stocks had nudged higher in recent trading sessions, rising 1.1 percent on Monday and nearly 5 percent over the past week, as investors increasingly bet on the Fed’s ability to lower inflation by raising interest rates without slowing the economy to the point of tipping it into a severe downturn.

But higher-than-expected August inflation data released on Tuesday caught investors off guard, sending stocks lower and prompting a rapid re-pricing of how much the Fed may need to raise interest rates to rein in rising prices.

“We are not out of the woods yet,” said Luke Tilley, chief economist at wealth manager Wilmington Trust. “We can’t even see the edge of the woods from here.”

Bankers and investors clung to expectations that even with a more rapid pace of interest rate increases, which slow the economy by raising borrowing costs for companies and consumers, the Fed may yet stick a so-called soft-landing, lowering inflation but avoiding a severe downturn. Yet there was also broad-based acknowledgment that the Fed’s task has been made harder in light of inflation remaining higher than expected.

“The longer the economy holds on, the longer household balance sheets can withstand these high prices, the more aggressive the Fed has to be in the future,” said Lauren Goodwin, an economist at New York Life Investments.

The two-year Treasury yield, which is sensitive to changes in the forecast path of interest rates, shot higher after the numbers were released, rising above 3.75 percent, a fresh high for the year.

Solid data on the labor market earlier this month pointed to the resiliency of the economy after several rate increases this year. Coupled with policymakers’ persistent message that they have yet to complete their task of lowering inflation through higher rates, investors had already come to expect another big rate increase, of three-quarters of a percentage point, when the Fed meets next week. For a time, some had bet on a half-point increase as the more likely option.

Following the inflation data, bets that the Fed would move aggressively when policymakers meet next week solidified, with some even starting to price in the possibility that the central bank could raise rates by a full percentage point, which would be its largest rate increase since 1984.

And the U.S. dollar, which had weakened for four days straight against a basket of currencies representing America’s major trading partners, swiftly strengthened on Tuesday, gaining 1.4 percent.

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