- The stock and bond markets pulled a sharp 180 this week.
- After prolonged sell-offs, both rallied on a renewed outlook for Fed rate cuts.
- A trifecta of events suggests the Fed can be more aggressive than previously thought.
Stocks and bonds staged a major turnaround this week thanks to a perfect storm of factors that recalibrated investor expectations for rate cuts in the coming year.
The S&P 500 is on pace to soar by more than 3% in five days, which would be its best weekly gain since Donald Trump’s election win in November. The Dow and the tech-heavy Nasdaq are also trending toward weekly surges of 4% and 2.5%.
The upward move follows the erasing of the postelection gain for the S&P 500, which fell by more than 5% from December highs.
Meanwhile, bonds have also rallied, with the 10-year US Treasury yield sliding by 14 basis points this week. (Bond prices and yields move inversely.) Before the shift, yields had increased by more than 100 basis points since mid-September.
The tandem reversals represent a reset of rate views as investors eye more monetary easing from the Federal Reserve than was penciled in a week ago. 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 has investors leaning into a more dovish scenario.
The first 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 by 3.2% year over year, slightly lower than the 3.3% economists were expecting.
Traders adjusted their outlook for Fed rate cuts in the coming year, and the 10-year Treasury yield slid by 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 argued that the data should put to bed any fears that the Fed could hike rates again this year amid a hot economy and higher inflation as a result of the new administration’s policies.
The good news continued on Thursday with the release of retail-sales data that missed estimates and decelerated from the prior month. Sales rose by 0.4% year over year in December, lower than 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. Christopher Waller told CNBC on Thursday said the central bank could cut rates in the first half of the year if inflation data continued to improve.
Waller said that if inflation slowed enough, the Fed could issue more rate cuts than previously anticipated, adding 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 betting that the Fed could take on a more aggressive easing cycle in 2025 than previously thought.
The CME FedWatch tool indicated the probability that the Fed would cut rates three times or more rose to 20% on Friday, up from 7% a week ago.
