What does the CPI report mean for the stock market?

Hitting rock bottom usually isn’t something people look forward to. But for investors hungry for relief from the latest market selloff, rock bottom couldn’t come soon enough. 

The tech-heavy Nasdaq is trading at its lowest level since November 2020. The Dow Jones Industrial Average has had six straight weeks of losses and the S&P 500 and Nasdaq experienced five straight weeks.  

The market selloff comes as the Federal Reserve is aggressively playing offense against the highest level of inflation in 40 years. In doing so, the central bank recently raised interest rates by 50 basis points, the biggest hike in more than 20 years. That came in addition to the Fed’s 25 basis point hike in March, the first rate increase since 2018. 

Investors took a slight sigh of relief from April's consumer price index report which found that the annual rate of inflation ticked down to 8.3% from 8.5% in March. Even though any slowdown is positive, economists polled by Dow Jones predicted a larger deceleration to 8.1%. The core rate, excluding the volatile food and energy prices, rose 6.2% in the 12 months to April, also missing forecasts for a slowdown to 6.0%.

Stocks initially moved higher with the Dow up more than 1% earlier in the day. But as of 1:56 p.m. EST the Dow was down 0.7%, or 221 points. The Nasdaq took even more of a plunge shedding 2.84%, or 334 points. The S&P 500 was down 1.45% or 58 points.

"It’s a slice of less bad news for a market that’s priced in a lot of bad news," Callie Cox, U.S. investment analyst at eToro, said in a note published Wednesday.

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When will inflation go down?

Don't expect inflation to ease significantly any time soon, economists said.

"Inflation remains widespread, making it all the more difficult to curtail," wrote Sarah House, an economist at Wells Fargo, in a commentary. "More than 60% of categories have seen prices rise more than 5% over the past year—a slight improvement over March but otherwise the most in decades."

One of the most worrying trends in the April report is how fast rents are rising and are likely to continue increasing, economists said. 

The report showed "the hottest pace for rents since the late 1980s and the hottest pace for home ownership costs since the early 1980s," said Diane Swonk, chief economist at Grant Thornton, in a commentary. "Worse yet, much of the surge in shelter costs - the largest single component of the CPI - are still ahead of us. It takes at least a year for an acceleration in rents and homeownership costs to show up in inflation measures; both were still accelerating in the first quarter."

Rent prices tend to lag by up to 18 months because renewals typically happen once a year, and housing components of CPI are 30%, the single largest weighting, of CPI.

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Living month-to-month 

On a month-to-month basis, inflation increased by 0.3% in April, posting the smallest gain since August 2021 but still more than consensus forecasts for a 0.2% rise.

"Coming into today’s report, investors and policymakers had hoped that some easing in the monthly rate of change would be apparent. They were almost certainly disappointed," said Jim Baird, chief investment officer at Plante Moran Financial Advisors.

The monthly figure can jump around a bit, some analysts noted. For example, energy prices eased after President Joe Biden said at the end of March the U.S. would release one million barrels of oil per day from its strategic reserves to ease high gas prices for consumers.

That may have helped contribute to the 6.1% drop in gas prices last month compared to March. The drop in gas prices alone kept the overall CPI from rising an additional 0.3%.

However, prices have since climbed again. The national average for a gallon of unleaded gasoline rose on Wednesday to a record high of $4.40, not adjusted for inflation, according to AAA. 

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Will the Fed continue to raise interest rates?

Even though the annual rate of inflation slowed a bit in April, it won't prompt the Fed to ditch its aggressive rate hike cycle, economists said.  

Data released after the Fed’s policy meeting last week showed unit labor costs surged 11.3% from a year ago in the first quarter, well above the overall pace of inflation and the fastest pace since 1982.

Fear of what economists call the wage-price spiral – or when an increase in wages leads to higher prices and then loops back again to push wages even higher to start the cycle again – is what the Fed is now focused on, economists said. 

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“Tight labor conditions are where the Fed seems to feel it can help shrink inflation,” wrote John Lynch, chief investment officer for Comerica Wealth Management, in a commentary.  “The goal is to increase interest rates and thereby slow demand for labor in an effort to slow the pace of employment cost increases.” 

When the Fed raises rates, it becomes more expensive to borrow money, which leaves people with fewer funds to invest. By taking such action, the Fed hopes to slow down the economy without causing a recession.   

Swonk estimates the unemployment rate must rise above 5% for inflation to cool to the Fed’s 2% target. On Friday, the Department of Labor said the jobless rate was unchanged at 3.6% in April. 

If inflation continues to level out, the Fed eventually may be able to take its foot off the brakes. But one month’s read on inflation won’t be enough to convince the central bank to back off, Powell told reporters last week. 

“We'd want to see evidence that inflation is moving in a direction that gives us more comfort,” he said, adding that the Fed would “just go back to 25 basis point increases” if inflation appears to be slowing as opposed to eliminating rate hikes.  

Investors are looking for “any sign of softening CPI,” said Michael Reynolds, vice president of investment strategy at Glenmede. “That may tame some of the fears that the Fed really needs to tighten particularly hard in order to bring inflation under control.” 

Will bond yields continue to rise?  

If you’re looking for clues on when the market selloff will end, pay close attention to yields on 10-year Treasury notes, said Keith Lerner, co-chief investment officer at Truist. 

Traditionally, 10-year notes are considered one of the safest investments. In times of heightened market uncertainty, investors tend to flock to bonds which sends yields lower and bond prices higher. Just the opposite is happening lately.  

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Ten-year yields went above 3% on Wednesday following the CPI release. That's the highest level since late 2018. This comes as the Fed is selling bonds as part of its effort to raise interest rates and investors are hesitant to hold onto bonds due to concerns about the Fed not having a good handle on inflation, Lerner said.

But yields dipped to 2.915% as investors bought more bonds. 

That’s somewhat of a good sign for markets because it demonstrates that yields may be stabilizing as opposed to continuing to move higher, he said. “Stability in yields would suggest growing investor confidence that rate hikes are now being largely priced in and growing confidence that inflation is peaking.”

It also would help calm some of the stock market volatility since it is closely tied to moves in the bond market, Lerner said. 

As for stocks, there are some signs that the market may have hit rock bottom.

In any given year, the S&P 500 has averaged a maximum intra-year pullback of 14%, according to Lerner’s analysis. That’s in line with the pullback the S&P 500 is currently experiencing from its high earlier this year.

But that’s not to say that markets can’t go even lower. Reynolds said we’re not at rock bottom yet and could have a way to go based on his assessment of current market conditions. 

Should you buy stocks now? 

“12 months from now, these prices will look very attractive,” said Tim Courtney, chief investment officer of Exencial Wealth Advisors. So it’s a good time to buy the dip, bearing in mind that it is impossible to perfectly time the markets to buy an asset at its lowest point, he said.  

As for asset classes, Courtney is keeping an eye on small-cap stocks, or companies that are valued at less than $2 billion. “They're undervalued,” he said. The S&P small-cap 600 index, an index comprised of 600 publicly traded small-cap stocks, is down more than 13% in the past year. While the S&P 500 index is down around 4.5%. 

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Tech stocks, which have been getting clobbered during the selloff, also are attractive to buy right now, he added.  

Meanwhile, Reynolds is telling clients to buy more short-term bonds while prices are still low and yields are high.

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Elisabeth Buchwald and Medora Lee are personal finance and markets correspondents for USA TODAY. You can follow Elisabeth on Twitter @BuchElisabeth and sign up for our Daily Money newsletter here