By Stocks and bonds have staged a major turnaround this week thanks to a perfect storm of factors that have recalibrated investor expectations for rate cuts in the coming year.
The S&P 500 is on pace to soar more than 3% over the past five days, which would be its best weekly gain since Donald Trump’s election win in November. The Dow and tech-heavy Nasdaq are also trending towards weekly surges of 4% and 2.5% respectively.
The upward move comes on the heels of the S&P 500 recently erasing its post-election gain, falling more than 5% from December highs.
Meanwhile, bonds have also rallied, with the 10-year US Treasury yield sliding 14 basis points this week. (Bond prices and yields move inversely to one another.) Prior to the shift, yields had soared more than 100 basis points since mid-September.
The tandem reversals represents a reset of rate views as investors eye more monetary easing from the Fed than had been penciled in a week ago. Just last week, a surprisingly strong December jobs report had the opposite effect on markets, with some on Wall Street surmising that the Fed’s next move might be a rate hike.
The situation has been fueled by a trifecta of developments this week that have investors leaning into a more dovish scenario.
The first ingredient came on Wednesday when traders took in a cooler-than-expected December inflation report. Headline inflation came in as anticipated, but core inflation — which excludes volatile food and energy prices, rose 3.2% year over year — slightly lower than the 3.3% core price growth economists were expecting.
Traders quickly adjusted their outlook for Fed rate cuts in the coming year, causing the 10-year Treasury yield to slide as much as 14 basis points on Wednesday.
“Core Inflation isn’t accelerating and that’s the story,” Jamie Cox, a managing partner at Harris Financial Group, said following the report. “The market may have had its hair on fire about inflation running away again, but the data do not support that conclusion. What we are seeing is the typical ebb and flow of the data as inflation is being pushed out of the system,”
Others noted that the data should put to bed any fears that the Fed could potentially hike rates again this year amid a hot economy and the potential for inflation to rise as a result of the new administration’s policies.
The good news continued the following day, with the release of retail-sales data that missed estimates and decelerated from the prior month. Sales rose 0.4% year-over-year in December, down from the consensus expectation of 0.6%.
Investors see the slightly weaker economic data as good news, as a cooler economy gives the Fed more breathing room.
The final component that helped stocks at the end of the week was dovish commentary from a top Fed official. Fed Governor Christopher Waller told CNBC on Thursday said the central bank could cut rates in the first half of the year if inflation data continues to improve.
If inflation slows enough, the Fed could issue more rate cuts than previously anticipated, Waller said, noting that as many as three or four quarter-point rate cuts were possible in such a scenario.
“As long as the data comes in good on inflation or continues on that path, then I can certainly see rate cuts happening sooner than maybe the markets are pricing in,” Waller added.
Investors have pushed out the possibility of another 25 basis-point rate cut until June, but traders are placing bets that the Fed could take on a more aggressive easing cycle in 2025 than previously thought.
The odds that the Fed could cut rates three times or more rose to 20% as of Friday, up from just 7% odds priced in a week ago, according to the CME FedWatch tool.
