Markets Drop as Investors Fear the Effects of Higher Rates

Stocks tumbled on Thursday as investors feared that central banks were prepared to continue raising interest rates to bring down inflation despite signs that economies were already slowing.

The S&P 500 closed with losses of 2.5 percent, adding to a downturn that came after the Federal Reserve announced a half-point rate increase on Wednesday. The tech-heavy Nasdaq composite index fell 3.2 percent and is down about 31 percent since the beginning of the year. The Bank of England and European Central Bank on Thursday also raised their policy rates by half a point.

“Risk aversion is returning as investors focus on global central bank tightening, rising recession risks and softer economic data, which suggests that the U.S. economy is seeing larger parts weaken now,” said Edward Moya, a senior market analyst at the foreign exchange brokerage OANDA.

Inflation F.A.Q.

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What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today. It is typically expressed as the annual change in prices for everyday goods and services such as food, furniture, apparel, transportation and toys.

What causes inflation? It can be the result of rising consumer demand. But inflation can also rise and fall based on developments that have little to do with economic conditions, such as limited oil production and supply chain problems.

Is inflation bad? It depends on the circumstances. Fast price increases spell trouble, but moderate price gains can lead to higher wages and job growth.

How does inflation affect the poor? Inflation can be especially hard to shoulder for poor households because they spend a bigger chunk of their budgets on necessities like food, housing and gas.

Can inflation affect the stock market? Rapid inflation typically spells trouble for stocks. Financial assets in general have historically fared badly during inflation booms, while tangible assets like houses have held their value better.

Investors have been looking for signs that central banks will slow the pace of tightening. Even though the Fed and others this week announced smaller rate increases than in previous meetings, none were willing to declare victory over inflation. The Bank of England, which has raised rates in nine consecutive meetings, estimated that the British economy was already in recession, but pledged to “respond forcefully” if inflation proved persistent. The European Central Bank said that rates would “still have to rise significantly and at a steady pace” to tame price pressures.

The drop in stockspulled the index into a loss for the week. The S&P 500 is down more than 18 percent since the beginning of the year. In addition, 10 of the 11 sectors of the benchmark index are down so far this year. Energy, the best-performing sector, is up more than 53 percent since January. On the other hand, the communication services sector, which includes companies like Walt Disney, Netflix and AT&T, is down about 40 percent since the beginning of the year.

“The markets continue to take two steps forward and three steps back and one step forward and two steps back,” said Ed Cofrancesco, the chief executive of the International Assets Advisory.

“We believe that the market is going to continue to mambo and make lower lows and lower highs,” Mr. Cofrancesco said. “As part of that mambo, the market is going to overreact to good news and it’s going to overreact to bad news.”

Understand Inflation and How It Affects You

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  • Your Paycheck: Inflation is taking a bigger and bigger bite out of your wallet. Now, it’s going to affect the size of your paycheck next year.

Policymakers at the Fed and other major central banks have expressed their determination to bring stubbornly high inflation under control by raising rates to cool their economies, even if that means higher unemployment and lower growth. When asked about the possible economic pain caused by the Fed’s policies, Jerome H. Powell, the Fed chair, said that a failure to rein in rising prices would be more painful.

“We have more work to do,” Mr. Powell said on Wednesday, with forecasts by Fed officials suggesting that they expected rates to peak higher and remain elevated for longer than they previously predicted. That could squeeze the economy harder; worse-than-expected retail sales data released on Thursday showed that consumers were wary of spending in November, the traditional start of the holiday shopping season despite promotions like Black Friday.

Britain’s FTSE 100 fell nearly 1 percent and the Pan-European Stoxx 600 dropped 2.9 percent.

The yield on the U.S. 10-year Treasury note fell slightly. Oil prices traded lower while the dollar rose 0.8 percent against a basket of other major currencies.

“Traders are still, though, taking a look at the big picture and we’re going to see a global economic slowdown in the first half of next year and I think the recession risks are elevated,” Mr. Moya of OANDA said.

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