Macro

VIX Surges 7%, Dow Plummets Amid Inflation Fears; Only One Fed Rate Cut Expected in 2024

VIX surges 7%, Dow drops as traders now expect only one Fed rate cut in 2024 amid inflation concerns.

By Barry Stearns

5/23, 15:53 EDT
S&P 500
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Key Takeaway

  • The VIX surged over 7% as inflation concerns spiked, causing the Dow to experience its worst day in over a year.
  • S&P Global's PMI report showed rising input prices, particularly in manufacturing, leading to renewed inflationary pressures.
  • Fed futures now price in only one rate cut for 2024, with expectations shifting from September to November.

Market Downturn Amid Historic Highs

Thursday saw a dramatic shift in U.S. financial markets, with a sharp downturn following an initial surge to historic highs in technology-heavy stock indices, driven by Nvidia Corp. The CBOE Volatility Index (VIX), often referred to as the market fear index, surged over 7% after hitting its lowest level since November 2019 earlier in the session. This spike in volatility underscored the market's sudden shift in sentiment.

Blue-chip stocks were particularly affected, with the Dow Jones Industrial Average, tracked by the SPDR Dow Jones Industrial Average ETF, experiencing significant losses. The S&P 500, tracked by the SPDR S&P 500 ETF Trust, also saw a broad sector selloff. However, chipmakers were the only industry to remain in the green, with the VanEck Semiconductor ETF showing resilience amid the broader market decline.

Inflation Concerns Resurface

The market's sentiment took a hit after S&P Global released its May private sector activity surveys. The Composite PMI Index, a gauge of overall business health, showed the highest expansion rate in two years. However, this seemingly positive news was overshadowed by rising input prices. "Input prices continued to rise sharply in May, with the rate of inflation accelerating to register the second-largest monthly increase seen over the past eight months," S&P Global reported.

Manufacturers faced the largest cost rise in a year and a half, driven by higher supplier prices for metals, chemicals, plastics, timber-based products, and increased energy and labor costs. Chris Williamson, chief business economist at S&P Global, noted that selling price inflation has increased, signaling modestly above-target inflation. He emphasized that the primary inflationary pressure now originates from manufacturing rather than services, making the Fed's 2% inflation target seem elusive.

Shift in Fed Rate Cut Expectations

Stronger-than-expected business sentiment growth and renewed inflationary concerns pushed Treasury yields up across the board, leading investors to reassess the likelihood of Fed interest rate cuts. Notably, there has been a significant shift in rate cut expectations. Fed futures are currently pricing in only 34 basis points of rate cuts by year-end, translating to just one rate cut. This marks a change from earlier expectations of a rate cut by September, now postponed to November according to the CME Group Fed Watch Tool.

The rate-sensitive two-year Treasury yield leaped by 6 basis points to 4.93%, eyeing the highest close since May 1. The dollar was the only gainer among major asset classes, with the Invesco DB USD Bullish Index Fund ETF reflecting this strength.

Bond Market Positioning

Bond traders are growing doubtful that the Federal Reserve will deliver the two interest rate cuts that were priced into the swaps curve just last week. Swaps markets are now pricing in around 40 basis points of rate cuts for the end of the year, with the first full 25 basis point easing priced into the November policy meeting. This shift comes after a benign inflation reading for April initially led markets to price in closer to 50 basis points of cuts.

Fed Governor Christopher Waller told CNBC, "If we get enough data going the right way, then we can think about cutting rates later this year, beginning of next year." However, he emphasized the need for "several more months of good inflation data" before supporting a policy easing.

Street Views

  • Chris Williamson, S&P Global (Bearish on inflation and manufacturing sector):

    "Input prices continued to rise sharply in May, with the rate of inflation accelerating to register the second-largest monthly increase seen over the past eight months... The primary inflationary pressure now originates from manufacturing rather than services. This shift has resulted in elevated rates of inflation for both costs and selling prices compared to pre-pandemic standards, implying that reaching the Fed’s 2% target still seems elusive."