The stock market is once again facing volatility.

 

U.S. indexes declined on Wednesday, with the Dow dropping by up to 600 points in the early hours as traders evaluated mixed inflation data.

 

According to the Bureau of Labor Statistics, the consumer price index for August showed prices rose by 2.5% year-over-year, marking the lowest headline inflation rate since early 2021. However, core inflation, which excludes food and energy sectors, exceeded expectations by rising 0.3% for the month instead of the anticipated 0.2%.

 

This unexpected increase in core inflation is concerning to investors, as it suggests inflation is persistent enough to possibly prevent a 50 basis-point rate cut at the Federal Reserve's upcoming policy meeting, which some investors had hoped for.

 

Following the CPI report, market sentiment shifted, with an 83% likelihood that the Fed will opt for a 25 basis-point rate cut next week, up from 56% a week earlier, as per the CME FedWatch tool.

 

Julian Howard, chief multi-asset investment strategist at GAM Investments, stated, "Another month, another slightly awkward data point," noting that core and services inflation seemed "firmly unvanquished" in the latest figures.

 

He added, "It does seem at least that a full 0.5% cut just became a little less convincing. Apart from anything else, the Fed's dual mandate means that it can't justify an aggressive or any cut solely on a weakening labor market."

 

While markets are disappointed about the reduced possibility of a larger rate cut, a 50 basis-point move by the Fed would have been a double-edged sword. Analysts noted that a 50 basis-point cut could have signaled significant economic slowing concerns, whereas a smaller 25 basis-point cut implies prolonged higher interest rates.

 

Investors are closely monitoring the job market for additional signs of weakness. Jobless claims on Thursday will be the next labor market indicator before the Fed meeting next week.

 

Gina Bolvin, president of Bolvin Wealth Management Group, stated, "The job market will remain influential," adding, "Today's inflation data confirmed a 25 basis-point cut for next week; 50 basis points is off the table."

 

Housing costs also contributed to the inflation rise, with the Labor Department noting that shelter inflation increased by another 0.5% in August.

 

Preston Caldwell, a U.S. economist at Morningstar, mentioned that shelter costs might decline soon, estimating market rent growth to be around 2% year-over-year. "As long as this remains, housing inflation will inevitably have to fall," he noted.

 

Despite adjusting their expectations, markets still foresee moderate rate cuts from the Fed by year-end. Investors are pricing in an 84% chance of a 100 basis-point or more rate cut by December, though future cuts will depend on jobs and inflation data.

 

Chris Zacarelli, chief investment officer of Independent Advisor Alliance, remarked, "If the economy continues to slow without plunging into a sudden recession, the Fed will be able to cut rates steadily by 25 basis points per meeting."

 

He added, "Given the current situation— with the Fed cutting rates, unemployment near historic lows, and a growing albeit slowing economy— the market should reach all-time highs again once we get through the volatility, which usually comes before most presidential elections."