Stocks Drop on Inflation, Economy Concerns

The S&P 500^® Index (SPX) and other major equity benchmarks fell to near three-week lows Tuesday as high oil prices and resurgent Treasury yields aggravated concerns about inflation and the economy, a day before the Federal Reserve's interest-rate-setting committee was due to conclude its two-day meeting.

Investors are nearly unanimous that the Federal Open Market Committee (FOMC) will leave its benchmark rate unchanged at its current range of 5.25% to 5.50%. Uncertainty remains, however, over the longer-term direction of rates and what sort of guidance Fed chair Jerome Powell may offer in his post-FOMC press briefing.

Schwab Senior Investment Strategist Kevin Gordon says the market's weakness reflects a combination of factors, including Fed-related jitters and economic concerns. Higher Treasury yields and oil prices—the former are near a 16-year high, while the latter have climbed to 10-month highs—have taken their toll, while the lower-than-expected August housing starts reported earlier Tuesday added to the gloom.

Weakness in transportation stocks and other cyclical sectors—that is, those considered to have greater exposure to the economic cycle—"is consistent with some of the weakness in parts of housing data this morning," Kevin says. Also, the rally in oil prices since mid-summer has raised concerns about inflation and damage to consumers' spending power.

Here is where the major benchmarks ended:

• The S&P 500 Index was down 9.58 points (0.2%) at 4,443.95; the Dow Jones Industrial Average (DJIA) was down 106.57 points (0.3%) at 34,517.73; the Nasdaq Composite (COMP) was down 32.05 points (0.2%) at 13,678.19.
• The 10-year Treasury note yield (TNX) was up about 5 basis points at 4.369%.
• Cboe's Volatility Index (VIX) was up 0.11 at 14.11.

Transportation and small-cap companies were among the market's weakest areas Tuesday. Both the Dow Jones Transportation Average (DJT) and Russell 2000 Index (RUT) ended at their lowest levels since late June. Technology companies were also lower, with the Philadelphia Semiconductor Index (SOX) down more than 1%.

Stocks on the move

The following companies had stock price moves driven by quarterly earnings, analyst ratings or other news:

• Deere & Co. (DE) fell 2.8% after an Evercore ISI analyst downgraded the agricultural and construction machinery maker's stock to "in line" from "outperform," citing concern over the farm economy.
• Instacart (CART) surged nearly 16% after the grocery delivery company earlier Tuesday held its initial public offering.
• Rackspace Technology (RXT) rallied 36% after Raymond James upgraded the cloud computing company's stock to "outperform" from "market perform," saying it expects the company's outlook to improve thanks to a recent reorganization.
• Rocket Lab (RKLB) fell 7.4% after an attempted satellite launch failed earlier in the day.
• Royal Caribbean (RCL) rose 2.5% after Truist upgraded its stock to "buy" from "hold," citing optimism over the outlook for booking and pricing in 2024 and 2025.
• Starbucks (SBUX) fell 1.5% after TD Cowen downgraded its stock to "market perform" from "outperform," citing "worrisome" macro and competitive pressures in China.
• Super Micro Computer (SMCI) shares rose 1.5% after Barclays initiated coverage of the information technology stock with an "overweight" rating.

Connecting the Fed's dots

The Census Bureau's housing data report for August painted a mixed picture. Starts were shy of expectations at a seasonally adjusted annual rate of 1.283 million. However, building permits topped estimates at 1.543 million, the highest monthly reading since last October.

Recent economic numbers have done little to divert the market from its fixation on the Fed. A pause in the Fed's rate-hiking campaign tomorrow appears to be a foregone conclusion, but investors will still be seeking clarity on the central bank's policy moves beyond this month, as well as its assessment of inflation and the economy.

Investors will likely scrutinize Powell's press conference for clues about the prospect of further rate hikes, as well as the potential for cuts in 2024. The Fed is also expected to update its "dot plot" projection for rates the rest of this year and next year.

Cooper Howard, a fixed income strategist at the Schwab Center for Financial Research, says the Fed is expected to hold rates steady this week "while leaving the door open for additional hikes this cycle.""

The dot plot and Powell press conference "could be a source of market volatility," Cooper says, with the Fed likely continuing to emphasize its inflation-fighting, "higher-for-longer" message on rates.

The Fed has raised rates 11 times since March 2022, including a quarter-point increase in late July. Late Tuesday, investors were pricing in a 99% implied probability the Fed will hold rates at the current range at this meeting, based on the CME FedWatch Tool.

Investors have also grown increasingly confident the Fed may hold rates steady beyond September. Based on the FedWatch Tool, odds that rates will remain at the current target range following the Fed's October 31-November 1 policy meeting were pegged at nearly 71%, up from 56% a week ago.