A Strong Rally Driven by Easing Inflation Fears
In a clear demonstration of investor confidence, US stocks rallied strongly on the back of the latest inflation data, which reinforced speculation that the Federal Reserve might cut interest rates as soon as September. The S&P 500 climbed by 1.5%, led by gains in the technology sector, while Treasury yields fell, particularly on shorter-dated bonds.
This positive movement comes just a day ahead of the highly anticipated Consumer Price Index (CPI) report. Earlier data showed that the Producer Price Index (PPI) rose less than expected, signaling that inflationary pressures might be easing. Categories within the PPI that feed into the Fed’s preferred inflation gauge—the Personal Consumption Expenditures (PCE) index—were largely subdued, reinforcing the market’s belief that the Fed might soon pivot to rate cuts.
“Markets searching for stability got more evidence of cooling inflation,” said Chris Larkin of E*Trade from Morgan Stanley. “This lower-than-expected reading will likely be welcomed by a stock market attempting to recover from its biggest pullback of the year.”
The Fed’s Potential Rate Cut and Its Implications
The cooling of inflation pressures has fueled expectations that the Fed could shift its focus back to supporting the labor market, which has shown signs of slowing. Raphael Bostic, President of the Atlanta Fed, indicated that while he is looking for “a little more data,” he is likely to support a rate cut “by the end of the year.”
This sentiment was echoed by Ian Lyngen of BMO Capital Markets, who noted, “There isn’t anything in Tuesday’s data suggesting the Fed will hesitate to cut rates next month.” However, Lyngen emphasized that Wednesday’s CPI report would be more crucial in shaping near-term policy expectations.
A survey conducted by 22V Research showed that 52% of investors expect a “risk-on” market reaction to Wednesday’s CPI report, although concerns about a potential recession remain high.
Market Reaction: A Four-Day Rally
As a result of these developments, the S&P 500 is on track for its largest four-day rally this year. The Nasdaq 100 jumped by 2.2%, with Nvidia Corp. leading gains among the mega-cap stocks. The Russell 2000, which tracks smaller companies, rose by 1.3%. In addition, Starbucks Corp. surged 22% after announcing leadership changes, further boosting market sentiment.
Treasury yields saw declines across the curve, with the 10-year yield dropping six basis points to 3.85%. Swap traders are now pricing in a nearly 40 basis-point Fed rate cut in September, with expectations for a total reduction of about 105 basis points in 2024.
“Disinflationary data is being celebrated by investors—not because it signals a slowing economy, but because it solidifies expectations for improved liquidity conditions via anticipated rate cuts starting as early as September,” said Dan Wantrobski of Janney Montgomery Scott.
The Bigger Picture: A Cautious Optimism
Despite the recent rally, some market analysts urge caution. Big tech stocks, which have been at the forefront of recent market fluctuations, remain under scrutiny due to high valuations. According to Chris Montagu of Citigroup Inc., US tech stocks are still under “significant pressure” as bullish investor positioning remains extended, making the sector vulnerable to any negative economic data.
While optimism around a “soft landing” persists, some believe that the Fed may need to implement more aggressive rate cuts to stave off a potential recession. Bank of America Corp.’s global survey indicated that despite recent turbulence, long positions in large-cap tech stocks continue to dominate, although to a lesser extent following the selloff.
Looking Forward: A Pivotal Week
As we look ahead, this week is considered pivotal for market data, especially after the “mini-panic” earlier in the month. If the CPI report shows a lower-than-expected inflation rate, it could give the Fed a “green light” to cut rates by 50 basis points at their next meeting, according to Chris Zaccarelli of Independent Advisor Alliance.
Financial markets have started flashing higher probabilities of an oncoming recession, driven by signals from the bond market and the performance of economically sensitive stocks. However, the prospect of an economic downturn remains an outside chance, with models from Goldman Sachs and JPMorgan Chase showing a material rise in market-implied odds of a recession.
“The runway is clear for the Fed to cut rates in September,” said Jamie Cox of Harris Financial Group. “If data like this persists, the Fed will have plenty of room to cut rates further this year.”
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