Recession: one foot in the door

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Here we are again.

Traders are hoping for some calm after the worst day for markets since the steep pandemic-driven volatility seen in 2020. The Dow (DJI) plunged nearly 1,300 points on Tuesday, leaving the index down 14% in 2022, while the benchmark S&P 500 (SP500) and tech-heavy Nasdaq (COMP.IND) tanked 4.3% and 5.2%, respectively, leaving them off 17% and 26% YTD. The broad selloff accelerated into the afternoon, in a force some attributed to outsized options activity, pulling every asset class deep into negative territory from stocks and oil to crypto and gold. 

What happened? There were hopes that inflation would come in weaker than expected, meaning the Fed could (eventually) ease up on its quantitative tightening cycle, but by the way things look now, it may double down on its aggressiveness. The CPI print rose 8.3% Y/Y in August vs. the 8.1% consensus forecast, while core CPI – which strips out volatile food and energy prices – rose more than expected to 6.3%, from 5.9% in July. That’s despite gas prices that have come down tremendously over the past 13 weeks, suggesting that price pressures are seeping into more parts of the economy, like housing, college tuition and medical services.

The inflation report is one of the last the Fed will see before its September meeting next week, but it did enough damage to already worrisome policy expectations. According to the CME’s FedWatch Tool, there is now a 1 in 3 chance the FOMC will raise rates by a monster full percentage point, while the probability of a half percentage point fell to zero (meaning 75 bps is a given). If that’s the case, a full-fledged recession could be around the corner, with rapidly rising borrowing costs pushing any prospects for a “soft landing” off the table.

Response from the White House: “Today’s data show more progress in bringing global inflation down in the U.S. economy,” President Biden wrote in a statement. “Overall, prices have been essentially flat in our country these last two months. Gas prices are down an average of $1.30 a gallon since the beginning of the summer. This month, we saw some price increases slow from the month before at the grocery store. And real wages went up again for a second month in a row, giving hard-working families a little breathing room. It will take more time and resolve to bring inflation down, which is why we passed the Inflation Reduction Act to lower the cost of healthcare, prescription drugs and energy.”