U.S. stocks surged to new all-time highs on Friday after fresh government data showed a significant cooling in inflation, bolstering investor confidence that the Federal Reserve will move to cut interest rates. The S&P 500 index briefly crossed the 6,800 threshold for the first time, capping a strong month for equities.
The rally was sparked by the September Consumer Price Index (CPI) report, which revealed that core inflation rose just 0.2% from the previous month. This figure, representing the slowest pace in three months, was welcomed by a market eager for signs that price pressures are easing, giving the central bank more leeway to support the economy.
Key Takeaways
- The S&P 500 hit a new all-time high, briefly surpassing 6,800, following the release of favorable inflation data.
- September's core Consumer Price Index (CPI) rose 0.2% from August, a slower pace that suggests inflation is moderating.
- The data has solidified market expectations for a Federal Reserve interest rate cut at its upcoming meeting, with another potential cut in December.
- Analysts believe the Fed will prioritize its full employment mandate as long as inflation remains under control.
Inflation Data Provides Relief to Markets
The latest CPI figures provided a dose of clarity for investors who have been navigating a period of limited economic information due to an ongoing government shutdown. On an annual basis, the core CPI, which excludes volatile food and energy prices, increased by 3.0%.
This moderation in price growth is seen as a critical signal for the Federal Reserve. Lindsay Rosner at Goldman Sachs Asset Management noted that there was little in the report to concern central bank officials. The data reinforces the narrative that inflation, while still present, is on a downward trajectory.
Investors reacted swiftly to the news. Jose Torres at Interactive Brokers commented on the market's enthusiasm, stating, "Investors are grabbing the bull by the horns after this morning’s lighter-than-anticipated CPI bolstered the case for a series of rate cuts this year and next."
Market Snapshot
- S&P 500: Rose nearly 1% to a new record.
- Nasdaq 100: Gained 1%.
- Dow Jones Industrial Average: Increased by 1%.
- 2-Year Treasury Yield: Slipped to 3.48%.
Federal Reserve's Path Forward
With the new inflation data in hand, market participants now see an interest rate cut at the Fed's next meeting as a near certainty. Interest-rate swaps indicate that traders have almost fully priced in a quarter-point reduction next week and another one in December.
The central bank has been focused on managing risks to the economy, particularly signs of a softening labor market. According to Art Hogan at B. Riley Wealth, the Fed has been clear about its priority. "The Fed has been clear that they are more focused on the softening labor data and will continue to defend their full employment mandate," he said, even if inflation runs slightly above its target.
"For a Fed focused on prudent ‘risk management,’ that should translate into another rate cut next week, and likely more to follow."
– Ellen Zentner, Morgan Stanley Wealth Management
The report aligns with private data gathered during the shutdown, which has not indicated a surge in inflation or a sharp decline in the job market. This consistency gives the Fed the justification it needs to continue its policy easing.
Quantitative Tightening in Focus
Beyond interest rates, another pressing issue for the Fed is its balance sheet. The process of reducing its $6.6 trillion portfolio, known as quantitative tightening (QT), may be nearing its end. Stress signals in money markets have led some strategists to believe the Fed could announce the end of QT as soon as its next meeting.
Michael Feroli at JPMorgan Chase & Co. expects a decision to halt the balance-sheet reduction next week. He believes Fed officials have done little to counter the market's expectation of a rate cut, making it the most likely outcome. The focus will then shift to Chair Jerome Powell's press conference for guidance on future policy moves.
What is Quantitative Tightening (QT)?
Quantitative tightening is a monetary policy tool used by central banks to decrease the money supply and reduce the size of their balance sheet. It is the reverse of quantitative easing (QE). During QT, the Fed lets its holdings of government bonds and other assets mature without reinvesting the proceeds, which effectively removes money from the financial system.
Market Outlook and Investor Sentiment
Analysts are largely optimistic about the market's trajectory through the end of the year. The combination of Fed easing, resilient corporate earnings, and seasonal trends is creating a favorable environment for stocks.
Chris Zaccarelli at Northlight Asset Management described inflation as "the dog that didn’t bark," noting that many bearish investors expecting a sharp price increase have been caught off guard. "With the Fed cutting rates and corporate profits continuing to increase, it’s hard to see an interruption of this year’s bull market," he added.
This sentiment is echoed by Scott Rubner at Citadel Securities, who pointed to an alignment of positive factors. "The best seasonal window of the year begins next week," he wrote, highlighting strong retail investor demand and the resumption of corporate buyback programs as additional tailwinds for a powerful year-end rally.
Despite the optimism, some challenges remain. Tariffs have contributed to price increases in specific categories like apparel and furniture. However, Josh Jamner at ClearBridge Investments observed that the pass-through to consumers has been less than expected, giving the Fed more room to act.
Overall, the market is interpreting the current economic landscape as one where mild inflation can coexist with stock market growth, provided that corporate earnings remain strong. As Bret Kenwell at eToro noted, "Stocks can do well in a mild inflationary environment, as we have seen over the past few years."
