Stocks fall as Wall Street braces for huge hike in rates

The S&P 500 was 0.8% lower in early trading, and Treasury yields jumped as expectations built for the Federal Reserve to hike interest rates drastically to slow the nation’s rocketing inflation.

The Dow Jones Industrial Average was down 260 points, or 0.8%, at 30,720, as of 9:57 a.m. Eastern time, and the Nasdaq was 0.9% lower.

Inflation and the Federal Reserve’s response to it have been at the center of Wall Street’s sell off this year. Wednesday’s discouraging data showed that inflation is not only still very high, it’s getting worse.

Prices at the consumer level were 9.1% higher last month than a year earlier, accelerating from May’s 8.6% inflation level. That also was worse than economists’ expectations for 8.8%.

The Fed’s main tool to combat inflation is to raise short-term interest rates, which it has already done three times this year. After Wednesday’s inflation report, traders now see it as a lock that the Federal Reserve will hike its key overnight interest rate by at least three-quarters of a percentage point at its meeting in two weeks.

That would match its most recent increase, which was the biggest since 1994. A growing number of traders are even suggesting the Fed will go for a monster hike of a full percentage point.

Traders are betting on a 37% chance of that, up from zero a month ago, according to CME Group.

The risk is that rate hikes are a notoriously blunt tool, one that takes a long time for its full effects to be felt. If the Fed ends up too aggressive with them, it could cause a recession. In the meantime, higher rates also push down on prices of all kinds of investments.

“Shock and awe from the Fed might cause a lot of collateral damage to the economy without really providing near-term inflation relief,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments .

“The Fed probably needs to temper people’s expectations about what they can do,” he said.

In the bond market, yields jumped as expectations built for an even more aggressive Fed. The two-year Treasury yield, which tends to closely follow expectations for Fed action, rose to 3.16% from 3.05% late Tuesday

It remains higher than the 10-year yield, which rose to 3.02%. That’s a relatively rare ocurrence, and some investors see it as an ominous signal of a potential recession.

The inflation data also sent immediate jolts into stock markets across Europe and for gold, with prices for all of them weakening after the report’s release.

Even with the moves, Wall Street’s reaction was a bit more muted than it was following the last report on inflation. A month ago, the reading on the consumer price index, or CPI, showed an unexpected acceleration in inflation. That dashed hopes among some investors that inflation was peaking, and it sent the S&P 500 down 2.9%.

Since then, parts of the economy have already slowed as a result of inflation and the Fed’s actions combating it, particularly the housing market. Prices for oil and other commodities have also regressed as worries about a recession pull down expectations for demand.

“While some will draw parallels with the shockingly bad May CPI report, the backdrop is markedly different — commodity prices have fallen sharply and we’ve seen clearer signs of an economic slowdown, both of which will contribute to weaker price pressures ahead,” said Michael Pearce, senior U.S. economist with Capital Economics.

AP Business Writer Joe McDonald contributed.