US stocks just suffered their biggest 1-day decline since June 2020. Here's why an inflation surprise tanked the market.

The US stock market suffered its worst one-day decline since June 2020 on Tuesday as stubborn inflation crushed investors' hopes of an early end to the Federal Reserve's campaign of interest rate hikes.

The S&P 500 and the Dow Jones Industrial Average fell more than 4%. Bonds, oil, gold, and cryptocurrencies were sold by investors.

The release of US inflation data on Tuesday was the catalyst for the selloff. The year-on-year inflation rate came in at 8.3%, down from 8.5% in July and from the 40-year high of 9% it reached in June.

The Fed was unlikely to curtail its rate hikes anytime soon. Concerns were raised that the central bank would approve a large rate increase at its September meeting and that interest rates might peak at a higher level than previously thought.

Why an inflation surprise tanked the stock market

Wall Street doesn't like rising interest rates because they affect the economy.

"Interest rates are to asset prices the same way gravity is to the apple," said Warren Buffet. Everything in the economy is powered by them.

Raising interest rates translate into bigger, guaranteed returns from Treasury bonds and savings accounts according to the renowned investor. Higher and higher returns are needed to justify the risk that investors take by owning stocks.

As the cost of servicing loans increases, it becomes harder for indebted companies to raise capital.

Raising interest rates makes borrowing more expensive, which affects consumer spending, investment, and exports. The result is slower economic growth, higher unemployment, and slower inflation.

The current bout of inflation is a product of not only strong demand, but limited supply. The economy and markets were shored up by near-zero interest rates and federal aid.

Russia's invasion of Ukraine has led to a surge in food and energy prices, as well as disrupting global supply chains.

The Fed may struggle to slow inflation to 2% a year. If the central bank doesn't stop hiking rates, the economy could go into a recession or even aflationary crisis.

On Tuesday, investors dumped stocks and other assets because higher monthly inflation fanned their fears of a nightmare scenario, where aggressive rate hikes fail to slow price increases, plunging markets and the economy into painful, lengthy downturns.

There is a growing disconnect in the market and the head of investment strategy at BlackRock says we are not headed towards a 2008-style housing collapse.