Wall Street Defies CPI Skeptics With Risk-On Rally: Markets Wrap

(Bloomberg) — Stocks surged and the dollar sank as softer-than-expected inflation data fueled bets the Federal Reserve could pivot to a smaller pace of hikes — a view taken with a grain of salt by market watchers saying officials may still be a long ways from achieving their goal.

Traders went risk-on Wednesday, with the S&P 500 set for its highest since May. A surge in the Nasdaq 100 drove the tech-heavy gauge nearly 20% above its June bottom. The Cboe Volatility Index slumped below 20, a level last seen in April. The greenback slid the most since the onset of the pandemic. Treasury two-year yields trimmed a plunge that earlier reached 20 basis points.

For a market plagued by fears about the Fed’s struggles to tame sky-high inflation, the July consumer price index brought a sigh of relief — with both core and overall measures coming in below forecasts. Swaps are now suggesting a move of 50 basis points as more likely in September than a repeat of the 75-basis-point increases that officials have opted to implement at their past two meetings.

“This is overall good news for risky assets,” wrote Florian Ielpo, head of macro at Lombard Odier Asset Management, adding that “a lower growth rate of prices does not mean the end of inflation, and naturally the end of hawkish central banking. Inflation remains a situation that requires the Fed’s attention and more importantly the Fed’s measures.”

Read: Mocked by Everyone, Stock Rally Is at Cusp of Chart Landmark

One danger of the stock-market bullishness right now is that could cause an easing in financial conditions that would actually go against the Fed’s goals. It’s also worth looking back to the early 1980s, when then Fed Chair Paul Volcker eased policy as inflation peaked and the economy entered a recession. But the moderation of price pressures proved to be much slower than officials wanted — and they had to tighten again months later.

In fact, the CPI surprise is just one piece of the intricate puzzle officials are playing with at the moment — and possibly over the next several months — with the central bank still miles away from reaching its inflation target. Food prices in the US soared the most since 1979 in July, keeping the cost of living painfully high even as lower gasoline costs offered some relief to consumers.

Officials have said they want to see months of evidence that prices are cooling, especially in the core gauge. The US central bank will probably continue raising rates into next year to bring down “unacceptably high” inflation, Chicago Fed President Charles Evans noted. His Minneapolis counterpart Neel Kashkari said “the idea that we’re going to start cutting rates early next year, when inflation is very likely going to be well in excess of our target — I just think it’s unrealistic.”

“The easing of financial conditions likely annoys the Fed, and we should not be surprised to see Fed speakers continue to try to talk down the market and risk assets,” said Christian Hoffmann, portfolio manager at Thornburg Investment Management.

More comments on CPI:

“The Fed still has significantly further to tighten and the US economy ultimately cannot avoid its fate. Enjoy today and the next few weeks, it won’t last for too long,” said Seema Shah, chief global strategist at Principal Global Investors.
“This data point will fuel talk of a policy pivot. But, for me, the issue really does boil down to the labor market. Wage growth is running red hot and absent a turn around in productivity, this will ultimately fuel higher prices,” wrote Neil Dutta, head of economics at Renaissance Macro Research.
“This is a step in the right direction but keep in mind we have many miles ahead of us before inflation normalizes. One month’s data point does not make a trend, however, so cautious optimism is likely the name of the game,” said Mike Loewengart, managing director of investment strategy at E*Trade from Morgan Stanley.
“Wow, finally the anecdotal evidence that inflation was easing has finally showed up in a mainstream inflation report. The Fed is rapidly losing its case for further tightening and this report reinforces for investors that either a new easing cycle has already begun or we are getting very close to one,” said Jim Paulsen, chief investment strategist at the Leuthold Group.

In corporate news, Tesla Inc. climbed after Elon Musk offloaded $6.9 billion of stock in the electric-vehicle maker to accumulate cash ahead of a trial that could force the billionaire to follow through on an agreement to acquire Twitter Inc. Wendy’s Co. became the latest restaurant chain to show signs of strain thanks to rising inflation as sales and restaurant margin fell short of Wall Street projections.

What to watch this week:

US PPI, initial jobless claims, Thursday
San Francisco Fed President Mary Daly is interviewed on Bloomberg Television, Thursday
Euro-area industrial production, Friday
US University of Michigan consumer sentiment, Friday

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Some of the main moves in markets:

Stocks

The S&P 500 rose 1.9% as of 2:41 p.m. New York time
The Nasdaq 100 rose 2.6%
The Dow Jones Industrial Average rose 1.4%
The MSCI World index rose 1.7%

Currencies

The Bloomberg Dollar Spot Index fell 1.1%
The euro rose 1% to $1.0313
The British pound rose 1.3% to $1.2237
The Japanese yen rose 1.6% to 132.89 per dollar

Bonds

The yield on 10-year Treasuries was little changed at 2.78%
Germany’s 10-year yield declined three basis points to 0.89%
Britain’s 10-year yield declined two basis points to 1.95%

Commodities

West Texas Intermediate crude rose 1.5% to $91.88 a barrel
Gold futures fell 0.3% to $1,807.40 an ounce

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