Dow falls 1,250 points in Wall Street's worst day since June 2020

NEW YORK—Stocks fell to their worst day in more than two years on Tuesday, sending the Dow Jones Industrial Average down more than 1,250 points, following the humbling realization on Wall Street that inflation is not slowing as much as it had hoped.

The S&P 500 sank 4.3%, its biggest drop since June 2020. The Dow fell 3.9% and the Nasdaq composite closed 5.2% lower. The sell-off ended a four-day winning streak for the major stock indexes and erased an early rally in European markets.

Bond prices also fell sharply, sending yields higher after a report showed inflation slowed to just 8.3% in Augustinstead of the 8.1% expected by economists.

The hotter-than-expected reading has traders bracing for the Federal Reserve to eventually raise interest rates even higher than expected fight against inflation, with all the resulting risks to the economy. Fears of higher interest rates sent prices tumbling for everything from gold to cryptocurrencies to crude oil.

“Right now, it’s not the journey that’s as worrisome as the destination,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments. “If the Fed wants to hike and hold, the big question is at what level.”

The S&P 500 fell 177.72 points to 3,932.69. The decline failed to dent its gains over the past four days. The index is now down 17.5% so far this year.

The Dow lost 1,276.37 points to 31,104.97 and the Nasdaq fell 632.84 points to 11,633.57. Big tech stocks fell more than the rest of the market as all 11 sectors that make up the S&P 500 sank.

Most of Wall Street entered the day thinking the Fed would raise its key short-term rate by a hefty three-quarters of a percentage point at its meeting next week. But the hope was that inflation was in the middle of a rapid fall back to more normal levels after its June peak of 9.1%.

The thinking was that such a delay would allow the Fed to reduce the size of its rate hikes by the end of this year and then potentially hold steady until early 2023.

Tuesday’s report dashed some of those hopes.

“This piece of data just showed that the Federal Reserve is not going to have the data to do anything other than continue on its rate-hike path for an extended period of time,” said Tom Martin, senior portfolio manager at Globalt Investments . “It just increases the chance of an actual recession.”

Many of the data in the inflation report were worse than economists had expected, including some that the Fed pays particular attention to, such as inflation outside of food and energy prices.

Markets saw a 0.6 percent rise in those prices in August from July, double what economists had expected, said Gargi Chaudhuri, head of investment strategy at iShares.

The inflation data was so worse than expected that traders now see a one-in-three chance of a full percentage point rate hike by the Fed next week. That would be four times the usual move, and no one in the futures market was predicting such an increase a day earlier.

The Fed has already raised its benchmark interest rate four times this year, with the last two hikes by three-quarters of a percentage point. The federal funds rate is currently in the range of 2.25% to 2.50%.

“The Fed cannot allow inflation to continue. You have to do whatever it takes to stop prices going up,” said Russell Evans, managing director of Avitas Wealth Management. “This shows that the Fed still has a lot of work to do to reduce inflation.”

Higher rates hurt the economy by making it more expensive to buy a house, car or anything else bought on credit. Mortgage rates have already hit their highest level since 2008, creating pain for the housing industry. The hope is that the Fed will be able to slow the economy enough to quell high inflation, but not enough to create a painful recession.

Tuesday’s data put hopes for such a “soft landing” under greater threat. Meanwhile, higher rates also push down the prices of stocks, bonds and other investments.

Investments seen as the most expensive or riskiest are the ones most affected by higher rates. Bitcoin tumbled 9.4%.

In the stock market, all but six stocks in the S&P 500 fell. Technology and other high-growth companies fell more than the rest of the market because they are seen as most at risk from higher rates.

Of course, the losses only put the S&P 500 back close to where it was before its recent winning streak. That move was based on hopes that Tuesday’s inflation report would show a more comforting slowdown. The subsequent disappearance fits what has become a pattern on Wall Street this year: stocks fall on worries about inflation, rise on hopes that the Fed may ease interest rates, then fall again when data undermines those hopes.

Treasury yields jumped immediately on expectations of a more aggressive Fed. The yield on two-year Treasuries, which tends to track expectations for Fed action, jumped to 3.74 percent from 3.57 percent late Monday. The 10-year yield, which helps determine where mortgage and other loan rates are headed, rose to 3.42 percent from 3.36 percent.

Expectations of a more aggressive Fed also helped the dollar add to its already strong gains this year. The dollar rose against other currencies in large part because the Fed has been raising rates faster and by wider margins than many other central banks.

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AP Business Writer Damian J. Troise contributed. Veiga reported from Los Angeles.

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