By Sruthi Shankar and Aparajita Saxena
(Reuters) - U.S. stocks reversed course to trade marginally higher on Wednesday as investors digested stronger-than-expected inflation data and a surprise drop in January retail sales, which shifted the focus from rising inflation to the prospect of stagflation.
The Labor Department's core Consumer Price Index, which excluded the volatile food and energy components, increased 0.3 percent in January. Economists polled by Reuters had forecast an increase of 0.2 percent. However, the year-on-year rise was unchanged at 1.8 percent.
The CPI data again raised the spectre of rising inflation and rekindled fears that the Federal Reserve could be forced to be more aggressive with monetary policy.
However, data showed U.S. retail sales fell 0.3 percent last month, the biggest decline in nearly a year and a surprise drop compared with economists' estimates of a 0.2 percent increase.
U.S stock futures fell more than 1 percent after data was released at 8:30 a.m. ET. An hour later, the stock market opened a third of a percent lower and has slowly pared losses since.
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"The initial reactions were amplified. We took a big dive in equity markets and now, as we digest the numbers a little bit further, people are starting to calm down," said Jim Smigiel, head and chief investment officer of Absolute Return Strategies at SEI Investments in Philadelphia.
"The number suggests the notion of stagflation, higher than expected inflation numbers and weaker than expected consumption which is a negative growth in the United States. That's not the narrative that the plethora of data really supports."
By 11:03 a.m. ET, the Dow Jones Industrial Average rose 0.1 percent to 24,664.07. The S&P 500 gained 0.35 percent to 2,672.2 and the Nasdaq Composite was up 0.82 percent at 7,071.13.
"I think the market is trying to find a bottom here. The market is not looking for any serious downleg from where we are today," Smigiel added.
Benchmark U.S. 10-year Treasury yields were near their session highs, but a key measure of near-term volatility fell, in contrast to its reaction to strong U.S. jobs and wages data earlier in the month.
The CBOE Volatility index was down at 21.10 points, slipping below 20 for the first time since Feb. 5 and well off the 50-point mark it hit during last week's sell-off.
Seven of the 11 major S&P 500 sectors were higher. The losers included the typically defensive sectors: consumer staples, utilities and real estate.
Among stocks, Fossil rose 55.7 percent after short-sellers rushed to cover their positions, a day after the watchmaker posted strong holiday-quarter sales.
Chipotle jumped about 14.3 percent after it hired Brian Niccol from Taco Bell as its next chief executive, which analysts said sparked hopes of a quicker turnaround.
Advancing issues outnumbered decliners on the NYSE by 1,727 to 1,067. On the Nasdaq, 1,907 issues rose and 864 fell.
(Reporting by Sruthi Shankar and Aparajita Saxena in Bengaluru; Editing by Savio D'Souza)