A surprisingly mild December inflation report has shifted market sentiment, helping to ease one of the stock market’s toughest headwinds—the rise in Treasury bond yields. The data has rekindled investor optimism about potential Federal Reserve rate cuts before the year ends, pushing stock prices higher. The initial pause in the two-year bull market came late last year, after a year-long rally that added $18 trillion to the S&P 500’s market value. The slowdown was driven by concerns over a hawkish Fed inflation outlook and uncertainty surrounding President-elect Donald Trump’s economic policies.
Shifting Concerns About Inflation and Interest Rates
December’s inflation report showed a cooling in core inflation, allaying fears that the U.S. economy would face further pressure from rising prices. The unexpected dip in core inflation was a positive sign for the Federal Reserve, indicating that the central bank may be successfully managing its dual mandate of achieving full employment and price stability.
Jamie Cox, managing partner at Harris Financial Group, pointed out, “Core inflation isn’t accelerating, and that’s the story.” This reassured investors that inflationary pressures might be fading, leading to more optimism about the Fed’s ability to control inflation.
Fed Rate Cut Expectations Rise
Prior to the report, investors had feared that stronger-than-expected jobs data and Trump’s policies on tariffs and immigration would stoke inflation further. The report has allayed some of those fears and boosted expectations that the Fed might cut interest rates sooner than expected. Currently, the FedWatch tool from CME Group suggests a 65% chance of a rate cut in June, with the potential for further reductions in September.
Impact on Treasury Yields and Stock Market
The positive inflation report sent Treasury yields tumbling. The benchmark 10-year Treasury yield dropped 11 basis points to 4.655%, while 2-year yields fell to 4.291%. This has led traders to realign their Fed rate forecasts, with expectations now leaning toward a more dovish Fed stance.
With Treasury yields sliding, U.S. stocks experienced a surge, with the S&P 500 gaining 1.75% to hit its highest level since January 6. The Nasdaq rose by more than 440 points, or 2.3%, reflecting strong market sentiment.
Earnings Season Boosts Market Confidence
Strong earnings reports, particularly from the banking sector, have added fuel to the market’s optimism. Goldman Sachs reported impressive profits, contributing to a positive earnings season start. Analysts expect S&P 500 earnings to grow by around 9.5% in the fourth quarter, with tech and financial stocks leading the charge.
Looking ahead, collective S&P 500 earnings are projected to rise to $275 per share this year, a 14.2% increase from 2024. These earnings growth expectations, along with a favorable inflation outlook and rate cut prospects, have analysts increasingly bullish on the market’s prospects.
Conclusion
The combination of cooling inflation, falling Treasury yields, and strong earnings reports has breathed new life into the stock market, with the S&P 500 gaining momentum. Investors are now more optimistic about the potential for Fed rate cuts and sustained growth in corporate earnings, setting the stage for continued gains in the months ahead.
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