Market Snapshot: U.S. stocks trade mixed as Nasdaq, S&P 500 edge higher after hotter-than-expected inflation report stokes higher interest rate concerns

The Nasdaq Composite is up 13% so far in 2023, but remains roughly 25% off its record high touched in November 2021 and it’s 16% year over year.

What’s driving markets

The January consumer price index showed the cost of living rising 6.4% year over year, down from 6.5% in December but hotter than the Wall Street forecast of 6.2%. On a month-by-month basis, prices increased by 0.5% in January compared with a slower gain of 0.1% in December.

The so-called core rate of inflation, which omits food and energy, advanced 0.4% for the second month in a row. It was slightly above the Wall Street forecast of 0.3% gain.

See: CPI shows U.S. inflation still sticky in January

José Torres, senior economist at Interactive Brokers said the CPI report reminds investors and the Fed that lower readings in the recent past don’t guarantee a downward trajectory. “This [CPI report] is sour news for market participants and the Fed alike, who have recently been cheering signs of ‘disinflation.’”

“Part of January’s inflation reacceleration is driven by the loosening of financial conditions, which calls for the Fed to tighten its monetary tightening stance and rhetoric. A failure to do so will lead to volatile inflation readings, an adverse reality when looking to achieve 2% inflation,” Torres said in email comment.

Inflation’s slow and stubborn decline has investors wondering how much higher the Federal Reserve will go with interest rates. They looked to comments from Fed officials who spoke after the release of inflation report for fresh insights into the central bank’s interpretations and expectations for inflation and interest rate hike.

Dallas Federal Reserve President Lorie Logan said on Tuesday she expected the central bank to keep nudging the benchmark rate higher, but she did not want the Fed to “lock in” a peak interest rate or how to get there. Meanwhile, Richmond Federal Reserve President Tom Barkin said inflation is cooling, albeit slowly. “I think there is going to be a lot more inertia, a lot more persistence that maybe we don’t want,” Barkin said in a Bloomberg television interview.

Philadelphia Fed President Patrick Harker also said on Tuesday that the central bank needs to keep raising interest rates at a gradual quarter-percentage point pace until they get above 5%.

The Fed raised the federal funds rate by 25 basis points earlier this month, bringing the benchmark rate to a range of 4.5% to 4.75%. Fed funds futures traders were pricing in a 91% probability for a quarter-point rate hike in March, followed by another 25 basis point hike in May, which will bring the fed-funds rate to 5-5.25%. Some traders anticipated 25 basis points of rate cuts by the end of 2023, according to the CME’s FedWatch tool.

See: Inflation could ‘easily’ take more than a year to decline enough for Fed to cut rates, trader says

The disinflation of recent months has encouraged investors to hope the Federal Reserve can soon stop raising interest rates, thereby allowing the economy to avoid a sharp contraction and thus support corporate earnings. This narrative has helped lift the S&P 500 by 7.8% so far this year.

But the rosy narrative is ringing hollow in the face of stubbornly high prices, Jennifer DeSisto, chief investment officer at Anchor Capital Advisors, said in an interview.

Some investors might have been hoping for inflation to ebb away faster — something that would’ve pushed the Fed to back away from more rate hikes. “I think the market had this view that inflation would be falling faster. … This is kind of catching them off guard at this point,” DeSisto said.

Jack McIntyre, a portfolio manager at Brandywine Global, said after Tuesday’s inflation data, investors are repricing out of the rate cuts, which is driving the yield on the 2-year Treasury higher because they had started to reflect rate cuts next year.

“But based on the data to this point, it looks like the markets were premature pricing the rate cuts,” he told MarketWatch via phone.

See: Fund managers and corporate executives have sharply reduced their recession expectations

The next big data point will be January retail sales on Wednesday, offering clues about the strength of consumer spending and the economy in the face of higher interest rates. Economists polled by Dow Jones expect the figure will show that retail sales rose 1.9% in January from the prior month. U.S. retail sales slumped 1.1% in December.

“If retail sales also show strength tomorrow, the Fed may have to increase their funds rate target to 5.5% in order to tame inflation,” said Maria Vassalou, Goldman Sachs Asset Management’s co-chief investment officer of Multi-Asset Solutions.

Meanwhile, the corporate earnings reporting season is drawing to a close. With most reports in, earnings for S&P 500 index companies were down about 2.0% during the last three months of 2022, the first decline since the third quarter of 2020. Most companies beat analysts’ forecasts, but the share of negative surprises rose.

Companies in focus

• Coca-Cola Co. KO, -1.28% shares were down 1.3% after the beverage giant matched consensus on its fourth quarter earnings and beat revenue expectations. “Organic revenue performance was strong across operating segments and included 12% growth in price/mix and 2% growth in concentrate sales,” the company said.
• Marriott International Inc.  MAR, +2.91% shares were trading 3.2% higher after the hotel operator’s fourth quarter profit and revenue beat estimates. The company also offered an upbeat outlook for the first quarter.
• Palantir Technologies Inc. PLTR, +19.19% shares rose 20% after the data software company reported its first-ever quarterly profit during 2022’s fourth quarter. 
• Shares of NVDIA Corp. NVDA, +4.82% jumped 5.2% after BofA Securities said it is upbeat about the company’s ability to capitalize on the push that companies are making to bake artificial intelligence into their offerings.

— Jamie Chisholm contributed to this report