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Inflation scares the market again.

August’s Consumer Price Index (CPI) report was hotter-than-expected.

Stocks tumbled the moment the news hit the tape. The Treasury market also took it on the chin with the 2-year yield surging 0.19% to climb above 3.75% for the first time since 2007. Moments like this are uncomfortable, if not downright scary. Let’s first understand what happened.

Markets had been expecting a 75 basis point increase in interest rates at the next Fed meeting, but that all changed after the CPI release. Now, there’s a nearly 20% probability of a full percentage point increase next week. The thinking was that the Fed would be able to ease its aggressive path by some degree after its September move. This report puts that into question.

The market’s reaction is not surprising given how sensitive it has been to economic data points in general. Recall last month how stocks soared after solid July jobs and inflation data. With today’s troubling news and intense reaction by traders, CPI clearly holds a much heavier weight in the future direction of markets and the economy.

Diving into the August release and why it’s so worrisome, the big trigger was core prices (excludes food and gas prices). While core prices were expected to be higher year-over-year, the increase was greater than anticipated. Higher costs for food, medical care, and new vehicles were exhibited – key areas for consumers. The surprise in the report was that shelter away from home (hotels, Airbnb, etc.) increased while many were expecting the declining trend in that area to continue.

The fear is that the trend in shelter costs could stick around longer than expected, threatening overall inflation. CPI’s housing and rent inflation methodology are rather backward-looking, so the headline and core rates might show stubbornly high readings for the next several months.

Now let’s look ahead. There’s cause for optimism in the bigger picture, though. I would point to the multiple signs that suggest overall pricing pressures should ease in the coming months: shipping costs, transportation costs, ISM service pricing, used car pricing, and other inputs are all falling or coming off highs.

The next indicators to watch for market direction will be retail sales and the University of Michigan Consumer Sentiment later this week. These data points will provide insight into the state of the consumer, whom I believe remains on firm ground as the reduction in gasoline prices plays a significant role in their spending and sentiment.

The Bottom Line

Today’s drop in stocks leaves the S&P 500 about where it was last Thursday. September is notorious for its volatility, and today’s CPI report was certainly a catalyst to bring volatility front and center. After more important data to come this week, all eyes will turn to Chair Powell and the rest of the Federal Reserve at next week’s policy meeting.

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Lindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.

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