North American stocks tumbled on Tuesday after a hotter-than-expected U.S. consumer inflation reading pushed back market expectations of imminent interest rate cuts, driving Treasury yields higher. The S&P/TSX Composite Index suffered its worst day in 17 months and the Canadian dollar, caught up in the shifting bets on where monetary policy is heading, fell by the most in almost a year.
Tuesday’s data showed that the Consumer Price Index (CPI) rose 0.3 per cent on a monthly basis in January, above the 0.2 per cent increase expected by economists. On a year-over-year basis, it gained 3.1 per cent, above Street expectations of 2.9 per cent.
The so-called core CPI, which excludes the volatile food and energy components, increased 0.4 per cent last month after rising 0.3 per cent in December.
“U.S. core CPI walloped Treasuries and sent shivers down the spines of anyone who still thinks the Fed should be in a big rush to cut,” Derek Holt, vice-president of Scotiabank Economics, said in a note. “The readings are starting to creep higher again over recent months from the summertime lows.” Bond prices move inversely to yields.
Markets have rallied this year on bets that the Fed would start trimming rates in May. Rate cuts are generally a positive for stock prices, as they reduce demand for competing fixed income investments while helping to bolster the economy.
The S&P 500 closed above 5,000 for the first time on Friday, powered by fast growing tech giants whose stock prices do particularly well when interest rates fall. The Canadian benchmark stock index has been an underperformer and remains more than 6 per cent below its all-time peak in early 2022.
After the release of the inflation data, bets by traders for a Federal Reserve rate reduction in May of at least 25 basis points dropped to 36.1 per cent, from about 58 per cent before the data, while expectations for June stood at 74.3 per cent, the CME FedWatch tool showed.
That was reflected in bond yields in both the U.S. and Canada. The yield on the benchmark U.S. 10-year Treasury note rose 14 basis points to 4.31 per cent, reaching its highest level since Dec. 1. The Canada five-year bond yield, closely watched because of its influence on fixed mortgage rates, was up 12 basis points, back to levels of three months ago before yields went into a downturn at the end of 2023.
Perceptions of where monetary policy is heading in the U.S. have considerable impact on Canadian markets. Traders have also been pushing back expectations for when the Bank of Canada will start cutting interest rates after absorbing the latest economic data on both sides of the border.
Interest rate swap markets, which capture traders’ views on future monetary policy, now suggest only 40 per cent odds that the bank will cut rates in June, according to Refinitiv Eikon data. That’s down from approximately 50-50 odds last Friday as Statistics Canada released a surprisingly strong jobs report, and 82 per cent odds just prior to a blowout jobs report in the U.S. on Feb. 2. The market is now pricing in only about half a percentage point decrease in the Bank of Canada key lending rate over the course of this year.
While money markets are putting 60 per cent odds on a Bank of Canada cut in July, some economists caution it could come later than that, especially if inflation stays at elevated levels and the housing market takes a strong upturn this spring. The next Canadian inflation reading will be released next Tuesday.
The increase in prices reported by the Labor Department on Tuesday occurred against the backdrop of labor market strength and economic resilience. But January is typically a strong month for inflation readings as businesses push through prices increases at the start of the year, which some economists believed were not completely addressed by the model used by the government to strip out seasonal fluctuations from the data.
They also pointed out that not all the drivers of inflation last month would go into the calculation of the personal consumption expenditures (PCE) price indexes, the measures tracked by the U.S. central bank to gauge progress toward its 2 per cent inflation target.
“It’s important not to overreact and jump to the assumption that an inflationary resurgence is developing,” said Seema Shah, chief global strategist at Principal Asset Management. “Inflation was partially driven by segments that are less important for the Fed’s favoured core PCE measure, while forward looking indicators suggest they will ease over the coming months.”
The TSX ended down 482.33 points, or 2.3%, at 20,584.97, its lowest closing level since Dec. 15.
“We’ve had a lot of publicity over the last six months about the possibility of a soft landing and a reduction in inflation and therefore a pullback in interest rates,” said Michael Sprung, president at Sprung Investment Management. “I think that’s looking to be further and further into the future.”
“Some of the valuations that have been built into companies on the prospect of lower rates are adjusting,” Sprung said.
The high-flying technology sector fell 4.6% as all 10 major sectors on the TSX lost ground. Shopify shares were down 12.5% after the e-commerce company forecast first-quarter revenue growth that was below estimates.
The materials group, which includes precious and base metals miners and fertilizer companies, lost 3.4% as the price of gold tumbled below US$2,000 per ounce.
Energy lost nearly 2% and heavily weighed financials ended 1.8% lower.
The loonie was trading nearly 1 per cent lower in afternoon trading at 1.3585 to the U.S. dollar, or 73.61 U.S. cents, its weakest intraday level since Dec. 13.
On Wall Street, rate-sensitive megacaps like Microsoft, Alphabet , Amazon.com and Meta Platforms fell between 1.6% and 2.2%. Such tech stocks are particularly sensitive to rising bond yields.
Real estate, consumer discretionary and utilities led losses among the 11 major S&P 500 sector indexes, with real estate falling to a low of more than two months.
The small-cap Russell 2000 index also fell 4.3%, the biggest one-day drop since June 16, 2022.
“Many Federal Reserve governors have come out in the last couple of weeks and given various indications that the cuts expected by the market in the first half of the year may have been premature. Now the CPI data are certainly reaffirming that picture,” said Bob Elliott, chief investment officer at Unlimited Funds.
The S&P 500 lost 68.14 points, or 1.37%, to end at 4,953.70 points, while the Nasdaq Composite lost 282.64 points, or 1.79%, to 15,659.91. The Dow Jones Industrial Average fell 522.05 points, or 1.36%, to 38,275.33.
It marked Dow’s biggest one-day percentage loss since March 22, 2023.
Among top movers, JetBlue Airways soared 21.6% after activist investor Carl Icahn reported a 9.91% stake, adding that the carrier’s stock is “undervalued.”
Arista Networks shares fell 5.5% after the cloud solutions provider forecast current-quarter adjusted gross margin below expectations, while Marriott International lost ground after the hotel operator forecast annual profit below Street expectations.
Shares of software firm Cadence Design Systems dropped 4% following a bleak quarterly sales forecast, while toymaker Hasbro lost after a steeper-than-expected drop in holiday-quarter sales and profit.
Tripadvisor stock jumped 13.8% as the online travel agency formed a special committee to evaluate deal proposals.
Declining issues outnumbered advancers by a 10-to-1 ratio on the NYSE and a 4.9-to-1 ratio on the Nasdaq. On U.S. exchanges 12.9 billion shares changed hands compared with the 11.71 billion moving average for the last 20 sessions.
With files from Reuters
Darcy Keith