US equities softened on Tuesday after inflation slowed less than expected, raising investor expectations that the Federal Reserve will respond with more interest hikes this year to combat rising prices.
Wall Street’s blue-chip S&P 500 and the tech-heavy Nasdaq Composite were down 0.4 percent and 0.3 percent, respectively, in morning trade in New York.
Fund managers turned bearish after year-on-year US consumer price inflation fell to 6.4 percent in January from 6.5 percent the previous month, slightly higher than economists had expected. Annual core inflation, which strips out volatile food and energy prices, fell to 5.6 percent from 5.7 percent in December, also slightly ahead of expectations, with prices rising 0.4 percent month-on-month.
The strong numbers drew fresh attention that high inflation will push the US central bank to raise rates higher than markets expect, as chairman Jay Powell warned last week.
“The Fed ended the year thinking that the economy is slowing, inflation is continuing to fall, the labor market is cooling. . . The January data throws all of that up in the air,” said Neil Shearing, chief economist at Capital Economics. “The labor market is heating up, the economy is looking better and inflation is slowly coming down. Put it all together and if you’re Jay Powell, you’re suddenly sleeping less easily.
A measure of the dollar’s strength against six other currencies rallied after the inflation data, but then gave up those gains to trade flat on the day. US government bonds sold off, with the yield on two-year Treasuries rising 0.08 percentage points to 4.62 percent, having previously dipped 0.03 percent. The yield on 10-year Treasuries rose 0.05 percent to 3.77 percent. Bond yields move inversely to prices.
The Fed raised its benchmark interest rate by a quarter of a percentage point in February to its highest level since September 2007 but warned “sustained increases” would be needed to control inflation.
Prices in the futures market show investors now expect rates to peak at just below 5.27 percent in July – up from 5.18 percent in the same month before Tuesday’s inflation numbers – with at least one interest rate cut for the rest of the year. Earlier this month, they expected a peak of around 5 percent in May, with two rate cuts by the end of 2023.
“People were positioned to print lower inflation, everyone wanted a [Fed] pivot,” said Lyn Graham-Taylor, senior rates strategist at Rabobank. “Now we’re seeing a shift in the narrative.”
In Asia, Hong Kong’s Hang Seng index fell 0.2 percent and China’s CSI 300 was steady. The Stoxx 600 in the European region closed 0.2 percent higher. London’s FTSE added less than 0.1 percent. British government bonds sold off sharply after the publication of US inflation figures, with the yield on the interest rate-sensitive two-year gilt rising 0.17 percentage points to 3.81 percent, the highest level since late October.
Brent crude, the international oil benchmark, fell 1.5 percent to $85.32 a barrel.