Stocks surged on Thursday in their best day since 2020 after a key inflation indicator came in softer than expected. Investors broke out their party hats as they interpreted the report to mean that peak inflation may finally be behind us. That means the Federal Reserve could be less aggressive with its rate hikes.
But Wall Street's memory is short: Less than two weeks ago Fed Chair Jerome Powell unambiguously said rates would remain higher for longer. Investors may be in for another letdown as sustained price pressures in housing, wages and energy mean the central bank still has a long way to go in its battle against inflation.
What's happening: The Consumer Price Index rose 7.7% for the year ending in October, a much slower pace of increase than the 8% economists had expected and the lowest annual inflation reading since January.
While Fed Chair Jerome Powell said earlier this month that the central bank still has "some ways to go" in its battle to tame inflation, sentiment is growing that the Fed may pivot and ease its current regime of historically high rate hikes to fight growing prices.
As of Thursday afternoon, markets were pricing in an 80% chance of a half-point rate increase at the Fed's December policymaking meeting. That would represent a deceleration after a run of four consecutive hikes of three-quarters of a percentage point.
But investors have a knack for getting their hopes up about a central bank pivot only to be crushed by another piece of negative data or hawkish messaging from a Fed official.
"The market's short-term reaction may be strong, but this is only one month's data," warned Yung-Yu Ma, chief investment strategist at BMO Wealth Management. "This entire year has seen the market careen from one narrative to the next. While the October CPI data may help to soften the Fed's trajectory a bit, it would take a lot more in coming months for the Fed to make an actual dovish pivot rather than stick to its 'higher for longer' recent messaging."
The inflation rate still remains far above the Federal Reserve's 2% target, and the pace at which inflation is declining is still very slow.
"Like an athlete running in a marathon, the Federal Reserve's attempt to bring inflation down toward its 2% target requires some patience, but importantly, moving forward matters even if it's early on in the race," said Rick Rieder, BlackRock's chief investment officer of Global Fixed Income.
It's not all bad news: The first mile in a marathon matters. The latest report bodes well for the economy and could mean that a soft or soft-ish landing, where inflation eases without recession, is still achievable. That's also good for markets.
"If the Fed doesn't have to tighten as aggressively, the economy will weaken less, and headwinds for stocks will be smaller," wrote Bill Adams, chief economist for Comerica Bank in a note.
What's next: This is just one report in a crowded landscape of economic data. But if inflation continues to moderate in November, that could be enough to convince the Fed to ease its rate of hiking.
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