U.S. stock markets plunge as inflation report suggests even more rate hikes to come

U.S. stock markets dove into the red on Tuesday after new data showed inflation is proving to be stubbornly resilient and will require much higher interest rates to bring it under control.

The Dow Jones Industrial Average closed down 1,276 points and the broader S&P 500 lost nearly 177 — a drop of roughly four per cent each — after new data showed the official U.S. inflation rate continues to be stubbornly high, up by 8.3 per cent in the year up to August.

Tuesday's sell-off was the worst day for the S&P 500 since the early days of the pandemic in March 2020. The technology-focused Nasdaq fared even worse, down by more than 600 points or more than five per cent. 

The U.S. central bank, the Federal Reserve, has already hiked its interest rate four times this year in an aggressive campaign to get ahead of inflation, but the data for August suggests those moves haven't been enough, and even more will be needed.

Higher interest rates are generally perceived as bad news for the stock market because they raise the cost of borrowing, and they also tend to slow down consumer spending, which is a drag on corporate profits.

"The Fed can't let inflation persist. You have to do whatever is necessary to stop prices from going up," said Russell Evans, managing principal at Avitas Wealth Management. "This indicates the Fed still has a lot of work to do to bring inflation down."

The inflation figures were so much worse than expected that traders now see a one-in-five chance for a rate hike of a full percentage point by the Fed next week. That would be quadruple the usual move, and no one in the futures market was predicting such a hike a day earlier.

Barry Schwartz, chief investment officer of Baskin Wealth Management in Toronto, said investors should be prepared for volatile days ahead until there are clear signs that inflation is headed lower.

"I think everybody should be resigned to the fact that it's going to be a a tough stretch until there's a clear indication that interest rates have peaked," he told CBC News.

Loonie, TSX fall 

The Toronto Stock Exchange fared comparatively better than its New York-based counterparts, but the main Canadian stock index was also lower as commodities like oil and gold got crushed in the gloom. The TSX closed own 358 points or 1.8 per cent. The loonie lost more than a cent to change hands below 76 cents US as investors fled toward the perceived safety of the U.S. dollar.

"A lot of the market participants went into this number really thinking that inflation was cooling and now they have to unwind those big trades," Schwartz said. "Could be some rough, choppy waters for the rest of September."