Traders watch a screen show the press conference held by Federal Reserve Chairman Jerome Powell on the floor of the New York Stock Exchange (NYSE) in New York, United States, following the announcement of Federal Reserve interest rates on July 31, 2019 .

Brendan McDermid | Reuters

The brand new consumer inflation data for April has spooked the markets and raised concerns that the Fed is wrong if rising prices are temporary.

If the Fed is wrong, it means it could start winding up its simple policy faster than expected and ultimately raise interest rates.

The consumer price index for April rose 4.2% yoy, the briskest pace since September 2008. Economists had expected a large 3.6% due to the base effects that drove last year’s weakness. However, the rise in the CPI surprised markets, pushing government bond yields higher and stocks lower.

The VPI measures a shopping basket with energy and housing costs. Excluding food and energy, core CPI rose 3% year over year and 0.9% monthly, compared to estimates of 2.3% and 0.3%, respectively.

Even lower stocks fell on concerns about inflation when the Labor Department released its report on Wednesday at 8:30 a.m.CET. Tech collapsed and losses on the Nasdaq accelerated. The index fell 2% in afternoon trading while the S&P 500 fell 1.6%.

“The tug of war has been tightened,” said Quincy Krosby, chief marketing strategist at Prudential Financial. Stocks were already under pressure as they feared inflation would pick up, squeezing margins and hurting corporate profits.

“How ephemeral is ephemeral?” Asked Krosby. “All this does is add more uncertainty in a market that is still expensive. Even with the withdrawals, it’s still expensive. … We need to see how the market takes this into account. Does it see this as part of the reopening?” ? ” ? “

The Fed has warned that there will be a short period of high inflation as the economy reopens and comparisons with last year’s pandemic-shocked economy make inflation look even hotter. Richard Clarida, vice chairman of the Fed, said Wednesday morning that he was surprised by the hot CPI data but also reiterated that the surge in inflation should be temporary.

The Fed has announced that it will tolerate inflation above its 2% target and consider an inflation margin to be acceptable. The concern, however, is that inflation could get too high and the Fed would be forced to hike interest rates and keep them hike, which will hurt stocks.

“There has been a pandemic everywhere,” said Mark Zandi, chief economist at Moody’s Analytics. Zandi said that while the CPI was surprising, he continued to believe the inflation spurt would be relatively short-lived. “Companies are only normalizing prices that they cut during the pandemic. However, underlying inflation is very robust. It is firm.”

Zandi said some areas, like used cars, had much stronger monthly earnings than expected. Used car prices rose 10% in April alone.

Airfares rose 10.2% and hotel and motel room rates rose 8.8% in April. Rental car prices rose 16.2% in April. Some goods such as children’s shoes also increased by 4.2% and men’s trousers by 2.3%.

“The Fed wants to boost inflation, but of course when you’re in the middle of it you’ll start drawing lines and worrying that the acceleration isn’t exactly what you want and we’re going to overheat,” Zandi said. “I’m sure that’s what investors will worry about today.”

Zandi said airlines and hotels had suddenly hiked prices faster than expected, but he still expected inflation to calm down in the summer. For the next year he is forecasting a pace of 2.5%.

Krosby said the stock market will now resent that inflation could rise for an extended period of time.

“You have to argue that it’s positive. It’s positive because the economy opens again. It rebounds when it opens, but there are other problems,” she said. “The Fed also wants higher inflation, but can you control that? … Be careful what you want.”

The 10-year government bond yield, moving against price, rose to 1.66% in early trading from around 1.62% according to the inflation report. It later rose to 1.69%.

The futures market’s expectations for a rate hike by the Fed have shifted from mid-2023 to December 2022, said Ian Lyngen, head of interest rate strategy at BMO.

“If the market really believed the Fed was reacting dramatically to that number, we would have a lot more than 4 basis points [0.04 percentage points] in government bond yields, “said Lyngen.” But that means, by the way, this doesn’t help the “forever lower” story. If these types of numbers persist, at some point the Fed will have to reconsider what they look like temporarily. “

Effects on the market

Technology and growth, the most expensive parts of the market, respond most to fears of inflation and the risk of rising interest rates. The Nasdaq, home to many high-flyers, was already down 6% in May.

As of the beginning of the second quarter, tech is the only major S&P sector down 0.2%. Materials increased more than 10.5% and energy increased 8.5% during the reporting period. These sectors benefit from inflation and can pass on higher prices.

Krosby said interest rate risk was higher for tech companies.

“Their cost of capital is higher for them. And the other aspect, if we look at the ratings in the marketplace, Big Tech is responsible for a lot of those higher ratings,” she said. “You can have a more expensive market when interest rates stay at their lows. If the calculation changes, you have to question the other part, which is how expensive the market is on a P / E basis.”

The VIX also rose 11% to around $ 24. The Cboe Volatility Index signals increased market volatility when it rises higher. It is calculated from the put and call options of the S&P 500.

“The question is whether all of this is falling at higher inflation levels.” said Krosby. “There is only so much the Fed can do to address concerns … even if you are in stock that says we will have higher inflation when the economy normalizes.”