Wall Street experienced its best Consumer Price Index (CPI) day in over a year, as a surprising slowdown in inflation triggered a stock market rally and a sharp drop in bond yields. This surge in equity prices fueled renewed optimism that the Federal Reserve could continue cutting interest rates in 2025.
The S&P 500 rose nearly 2%, reversing earlier losses and marking its most significant gain since the US elections. The drop in Treasury yields, with 10-year yields falling by almost 15 basis points, alleviated concerns that rates could reach 5%. Commodities also surged, with oil prices breaking through the $80 per barrel mark. This broad-based rally across assets was the strongest on a CPI day since late 2023, according to Bloomberg data.
December CPI Falls Below Expectations
The US CPI rose less than expected in December, boosting speculation that the Federal Reserve might lower rates sooner than anticipated. Swap traders now fully expect a rate cut by July, a sharp reversal from prior expectations following Friday’s strong jobs report, which had led to predictions that the Fed might hold off on rate cuts until the fall.
Steve Sosnick, Chief Strategist at Interactive Brokers, pointed out that the rally was sparked by the better-than-expected core CPI reading, but the magnitude of the move reflected the underlying market anxiety.
The Federal Reserve’s Next Move
Analysts believe that while the latest CPI report likely won’t lead to a rate cut in January, it strengthens the case that the Fed’s current rate-cutting cycle isn’t over. Tina Adatia from Goldman Sachs Asset Management noted that the market would be encouraged by the drop in core inflation, which eases pressure on both the stock and bond markets.
Chris Zaccarelli of Northlight Asset Management added that the report would reduce concerns about the Fed reversing course and raising rates. The S&P 500 rose 1.8%, the Nasdaq 100 climbed 2.3%, and the Dow Jones Industrial Average added 1.7%. The “Magnificent Seven” tech stocks jumped 3.7%, and the Russell 2000 gained 2%.
Risk Appetite Resurfaces
As investor sentiment turned positive, the Cboe Volatility Index (VIX), a key measure of market fear, dropped sharply. Riskier assets, such as money-losing tech stocks and heavily shorted shares, saw strong gains. Bitcoin rose close to $100,000, and the yield on 10-year Treasuries fell by 14 basis points to 4.65%.
Despite the easing of inflation, bond investors remain cautious, with some fearing that rising interest rates could curtail the bull run in equities. John Kerschner of Janus Henderson Investors noted that the latest CPI data had relieved fears of “nose-bleed” interest rates.
Market Outlook and Fed’s Stance
Krishna Guha from Evercore said the CPI print reinforces the view that markets had overreacted to inflation concerns. He believes the data supports the case for at least two rate cuts from the Fed in the coming months.
At the same time, market experts caution against expecting immediate drastic moves. Morgan Stanley’s Ellen Zentner emphasized that while the CPI report may dampen speculation about a rate hike, it is unlikely to change the Fed’s stance of keeping rates steady in January.
Seema Shah, Chief Global Strategist at Principal Asset Management, suggested that the market may experience volatility as it adjusts to the latest inflation data. However, if future CPI reports remain soft, along with signs of a weakening job market, a rate cut by March could become more likely.
Core Inflation Shows Signs of Easing
The core CPI, which excludes volatile food and energy prices, rose by just 0.2% in December—the smallest increase in six months. On a year-over-year basis, core CPI increased by 3.2%, still above the Federal Reserve’s target of 2%.
Allison Boxer from Pacific Investment Management Co. stated that while the Fed is unlikely to act immediately, the data provides some reassurance that inflation is easing. She believes the Fed will wait for more data before making a decision on future policy.
Fed Officials Cautiously Optimistic
Fed officials are cautiously optimistic about the inflation outlook. New York Fed President John Williams expressed confidence that inflation would continue to decline, but he did not give any indication of when further rate cuts might occur. Other Fed officials, such as Richmond Fed President Tom Barkin and Chicago Fed President Austan Goolsbee, also highlighted progress in reducing inflation while advocating for maintaining restrictive rates.
Seema Shah believes that the December CPI report is not enough to trigger an immediate rate cut but could pave the way for future cuts if inflation and payrolls continue to soften.
Conclusion
The latest inflation data offers hope that inflation may be easing, but it’s not yet enough for the Federal Reserve to change its course. Market participants should be prepared for more volatility in the coming months as the data continues to shift. However, the prospect of a few rate cuts by the Fed remains strong, potentially bringing further relief to both stocks and bonds.
Related topics:
