Dow Jones falls 800 points as inflation hits 40-year high

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By Nicole Goodkind, CNN Business

It was yet another week of losses for US markets after Friday’s steep declines.

The Dow Jones plunged more than 800 points after a key inflation report missed estimates and showed a higher-than-expected rise in the price of consumer goods.

The Dow closed down 810 points for the day, or 2.5%. The S&P 500 lost 2.7% and the Nasdaq fell about 3%.

May’s consumer price index rose 8.6% year-on-year, its highest level since 1981. Economists had forecast an 8.3% increase. The core index, which excludes food and energy prices, rose 6%, slightly above estimates of 5.9%.

These figures have shaken investors. Already worried about a possible economic slowdown, they now fear that the Federal Reserve will recognize inflation as entrenched in the economy and raise interest rates further.

The central bank is expected to announce an interest rate hike of half a percent next week, but based on this news, it could decide to go higher.

“We believe the US central bank now has good reason to surprise markets by increasing more aggressively than expected in June,” Barclays analysts wrote in a research note on Friday. “We realize it’s a close call and it could play out in June or July. But we are changing our forecast to predict a 75 [basis point] hike June 15th.

The move would be historic – the last time the Fed hiked 75 basis points was in November 1994, nearly three decades ago.

Analysts unfortunately appeared to be pricing in the potential for an interest rate hike on Friday. And while many analysts feared the Federal Reserve was doing too little too late to rein in rising inflation rates, they also worry that sudden large increases in interest rates will hurt the economy.

“The major risk to consumption, employment and the economy as a whole is not a slowdown in organic growth, but the extent to which extreme increases in energy and food prices could cause central banks to push against the rope, and [the economy could] essentially falling into a damaging policy error,” Rick Rieder, chief investment officer of Global Fixed Income at BlackRock wrote in a note.

Friday’s selloff was far-reaching, with stocks in the red on the New York Stock Exchange outnumbering stocks that rose about nine to one.

The White House conceded that Friday’s inflation figure was “uncomfortably high”, further fueling investor fears over political action.

Federal Reserve policymakers have historically focused on personal consumption spending and not the CPI as the preferred measure of inflation. But core PCE also rose 0.34% in April, bringing the measure’s year-over-year figure to 4.9%. That number was down a bit from 5.2% in March, but it’s still high.

“The likelihood of a recession in the next year is increasing,” Sung Won Sohn said. Professor of Finance and Economics at Loyola Marymount University and Chief Economist at SS Economics. “Inflation erodes the purchasing power of consumers.

Consumer spending accounts for about 70% of the US economy, and a real decline in that spending would be a big hit to gross domestic product. “The [Federal Reserve] now recognizes that it is way behind the inflation curve and needs to act more decisively,” Sohn said.

The Dow Jones had its 10th losing week in 11 and the S&P 500 and Nasdaq its ninth losing week in the past 10. The S&P 500 is now down about 19% from its January high and is once again approaching bearish territory.

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