The drop in U.S. stocks deepened in the final hour of Tuesday trading amid signs the Federal Reserve’s fight with inflation was not yet done. Shorter-dated U.S. bonds gained as investors bought the dip.

The S&P 500 Index’s 1.2 per cent drop sent the equities gauge below its average price over the last 50 days for the first time in more than three months, halting a streak of momentum that was by this measure the longest since September 2020. 

“In the near-term, dips below 4450 can be bought while rallies up to 4550 should be faded,” Adam Crisafulli, analyst at Vital Knowledge, wrote of the benchmark’s drop. “The inability of the SPX over the course of several weeks to set new highs has steadily eroded psychology.”

U.S. stocks sank after retail sales rose more than forecast, suggesting the economy can support higher rates and potentially dissuade decision makers from a policy pivot. Financials weighed on the S&P 500 benchmark after a warning from Fitch that the ratings firm may downgrade larger lenders like JPMorgan Chase & Co. or Bank of America Corp. while Discover Financial Services was the worst performer after its chief executive officer resigned. 

“The most recent data — retail sales — shows the economy is still hanging in pretty well,” Rhys Williams, chief strategist at Spouting Rock Asset Management, said by phone. “Clearly the economy is better than anybody expected six months ago.

Williams is skeptical that inflation can be brought down, and remain at, the central bank’s 2 per cent target rate this year. 

Fed officials are also sounding a cautious note. Minneapolis Fed President Neel Kashkari said at a conference Tuesday that while inflation has been coming down, “it’s still too high.” 

In earnings, Home Depot Inc. beat the average analyst estimate, suggesting that U.S. home improvement spending is performing slightly better than expected following an unprecedented boom during the pandemic. More insight into the state of the consumer will come later this week when Target Corp. and Walmart Inc. are set to report.

Investors are growing wary that consumer-facing companies will be able to maintain their pricing power for much longer as the lagged effects of the Fed’s policy tightening take hold.

“Eventually — and I think we’ll see some of that now — those margins get eaten away,” Bob Doll, chief investment officer at Crossmark Global Investments, told Bloomberg Television. “Because companies can only raise prices so far, and you’re already seeing consumers begin to make noise and balk and stop buying some things.”

“We’ve been — since the first of the year — saying recession starts sometime between Labor Day and the end of the year,” he added. Doll is sticking with that prediction though he expects it to be a mild downturn.

Shorter-dated U.S. Treasuries went higher as buyers stepped in amid a global bond selloff. Options traders have been recalibrating bets to accommodate the possibility that interest rates and inflation will stay high for longer. Yields on the 10-year reached 4.27 per cent, the highest since October before paring gains while the two-year dipped after moving above 5 per cent.

Investors are navigating a hawkish Federal Reserve, a slowdown in China and flare-ups across emerging markets after a record first half in stock markets. A devaluation in Argentina and Russia’s emergency rate hike on Tuesday to stem the ruble’s slide added to the risk-off sentiment.

Still, Bank of America’s latest global survey of fund managers found investors the least pessimistic on stocks since February of last year, before the Fed began one of the most aggressive tightening cycles in decades.

They increasingly expect no recession at all within the next 18 months, and a “soft landing” in the next 12 months remains the base case, BofA strategists led by Michael Hartnett wrote in a note.

Crude futures dropped to the lowest in a week as the prospect of a slowing economy in China weighed on sentiment.

In currencies, the British pound was the best performer in the Group of 10 as investors weighed the prospect of an outsized interest-rate hike after wage growth accelerated to the strongest pace on record. 

The focus later this week will be on UK inflation data due Wednesday, followed by minutes from the Fed’s July policy meeting, as traders seek clues on central banks’ next moves. 

Some of the main moves in markets:

Stocks

• The S&P 500 fell 1.2 per cent as of 4 p.m. New York time
• The Nasdaq 100 fell 1.1 per cent
• The Dow Jones Industrial Average fell 1 per cent
• The MSCI World index fell 1 per cent

Currencies

• The Bloomberg Dollar Spot Index rose 0.1 per cent
• The euro was little changed at US$1.0904
• The British pound rose 0.1 per cent to US$1.2702
• The Japanese yen was little changed at 145.55 per dollar

Cryptocurrencies

• Bitcoin fell 0.8 per cent to US$29,145.5
• Ether fell 0.9 per cent to US$1,825.93

Bonds

• The yield on 10-year Treasuries advanced two basis points to 4.21 per cent
• Germany’s 10-year yield advanced three basis points to 2.67 per cent
• Britain’s 10-year yield advanced two basis points to 4.59 per cent

Commodities

• West Texas Intermediate crude fell 1.9 per cent to US$80.96 a barrel
• Gold futures fell 0.5 per cent to US$1,934.30 an ounce