Tuesday’s Selloff Implies Markets Will Likely Retest June Lows 

The stock market saw a steep decline on Tuesday after the consumer price index (CPI) report showed that inflation came in higher than expected in August, shaking investors’ confidence and increasing the chances of another aggressive interest rate hike at the next FOMC meeting.

According to the U.S. Bureau of Labour Statistics (BLS), inflation rose 0.1% month-on-month in August as higher food and shelter costs offset a drop in gas prices. Year-over-year, inflation stood at 8.3% last month. Core inflation, which does not factor in volatile gas and food prices, rose 6% on a monthly basis. These compare with analysts’ expectations of a 0.1% decline in overall inflation and a 0.3% surge in core inflation.

The CPI print came just a week before the Fed’s September 20-21 meeting, where the U.S. central bank is expected to impose a third straight 75 basis points interest rate hike to bring down inflation closer to its 2% target. Some investors hoped for a bigger drop in inflation, which would increase the chances of the Fed slowing down the pace of interest rate hikes.

Although the 75bp rate hike was all but priced in for the next week, the hotter-than-expected CPI print has now pushed markets to start pricing in a 100bp rate hike. Citi economist Andrew Hollenhorst told clients this week that a 100bp rate hike is “possible but relatively unlikely.”

Still, the mere fact that the market has begun to price in such an aggressive move means that tech stocks are likely to stay under extensive selling pressure, especially in growth parts of the market.

On Tuesday, tech stocks took significant damage, with some tech titans, like Meta Platforms (NASDAQ:META) and NVIDIA (NASDAQ:NVDA), plummeting 9.4% and 9.5%, respectively. High-growth stocks were particularly hit by the selloff, with the likes of Cloudflare (NYSE:NET) and Unity Software (NYSE:U) tumbling 10% and 13.4%, respectively.

Just five stocks followed by the S&P 500 ended the session in the green. The slump offset almost all of the equities’ gains in the recent period, pushing the benchmark indices down closer to their lows reached in June.

Art Cashin, dictator of floor operations at UBS, said:

“I think we may even go back and retest the June lows.”

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A poll by Reuters showed that 44 of 72 economists expect the Fed to increase its fed funds rate by 75 bps, up from just 20% who said this a month ago. The remaining 28 economists expect the Fed to hike rates by 50 bps.

A third straight 75 bps hike would take the policy rate to the 3.00%-3.25% target range, the highest in 14 years.

Such a significant change in expectations has driven the U.S. dollar to a 20-year high against a basket of currencies. The U.S. dollar index currently stands at 109.67, up 18% this year.

However, hiking interest rates at such a fast pace carries its own risks. While the chances of the U.S. falling into a recession over the next year remain unchanged at 45%, the probability of the economic downturn happening over the following two years rose to 55% from 50%, the poll shows.

The gross domestic product (GDP) has already contracted in the previous two quarters--technically seen as a sign of recession. Moreover, the metric is projected to grow below its long-term average trend of 2% until 2025.

In reply to a separate question, over 80% of economists believe that the Fed will leave the rates unchanged for an extended period once the Fed funds rate peaks. At the same time, only a minority expects the central bank to cut the rates aggressively.

The CPI print ended the stocks’ run of four consecutive positive trading sessions. This negative surprise, coupled with increasing chances of a U.S. recession, is acting as a major overhang on stocks in the near term. More importantly for the markets, the latest CPI report pushes back any ‘Fed pivot’ that the markets were hoping for in the near term.

Given the bigger-than-expected rise in inflation for August, which will lead to more aggressive actions from the Fed, most stock analysts see stocks falling much lower to retest the June lows. Given the increased volatility, we may continue to see big-size moves as long as there remains uncertainty on what Fed Chair Powell and his colleagues will be forced to push inflation down.

In another market downturn, the tech sector is likely to feel the biggest pain as many of these growth stocks are contingent on securing new funds. This activity is getting more and more expensive as the Fed continues to tighten its monetary policy.

Written By: The Tokenist