Stocks Rally on View Fed 'Endgame' Is Nigh

Stocks climbed while bond yields sank as an unexpected inflation slowdown bolstered bets the Federal Reserve’s aggressive hiking cycle is now over — and the next move will be a cut in mid-2024.

More than 95% of the S&P 500 companies rose, with the gauge up about 2%. Tesla Inc. led gains in mega-caps and Nvidia Corp. extended its rally into a 10th straight session. Financial shares also surged, especially regional banks — which jumped 7%.

The Russell 2000 index of small caps added 4.5%. Two-year yields plunged 20 basis points to around 4.85%. The dollar fell 1%.

While Wall Street’s rally could risk a further easing of financial conditions — and ultimately complicate the Fed’s job — bets on a central bank “pivot” next year have increased. Fed swaps indicate the odds of another hike in the current tightening cycle have fallen to almost zero — with the market now pricing in a 50 basis-point rate cut by July from the current level of 5.25-5.5%.

Advisors’ Assessment

To Chris Zaccarelli at Independent Advisor Alliance, whether or not the economy can stay out of recession remains to be seen, but the market should continue to rally as investors begin to accept the view that higher rates are off the table.

“The last of investors not convinced the Fed is done are likely ‘throwing in the towel’,” said Bryce Doty at Sit Fixed Income Advisors. “The next Fed action is more likely to be a cut next summer than another rate increase.”

The drop in inflation suggests that recent monetary policy has been doing its job, which makes the prospect of a “soft landing” ever more likely, according to Richard Flynn at Charles Schwab UK. The news reinforces the probability that officials will “hold off” from further rate hikes, he noted.

“With the U.S. economy holding up, the inflation data are ‘soft-landing nirvana’ for the equity markets,” said Neil Dutta, head of economics at Renaissance Macro Research.

An intact disinflationary process means that the Fed can “sit tight for now” — which would lower the risk of an “overly restrictive policy”, according to Lauren Goodwin at New York Life Investments. Still, she cautions investors who are getting “too enthusiastic” as “financial conditions are now easing again, which keeps the Fed on guard and highly data dependent.”

The Fed’s challenge is that the market tries to jump to the “endgame” — risking a larger or sooner easing in financial conditions than the Fed itself would like to see, said Krishna Guha at Evercore ISI. “So expect Fed officials to maintain a very cautious and relatively hawkish tone.”