Stocks rose on Tuesday after a softer-than-expected inflation report for November cemented expectations that the Federal Reserve could slow its campaign to raise interest rates, which has weighed heavily on stock prices.
An early surge faded however, and the S&P 500 ended the day with a gain of 0.7 percent, after climbing more than 2 percent soon after the start of trading. The benchmark index is still down about 16 percent for the year.
For months, Wall Street has been looking for data that could encourage the Fed to moderate its interest rate increases, which the central bank has used to try to temper stubbornly high inflation but which also increase costs for companies and dampen consumer demand. The central bank is expected to raise rates by half a percentage point on Wednesday, which would represent a slowdown from increases of three-quarters of a point in previous meetings since June.
Investors now expect that the Fed will reduce the size of its rate increase again in February, with bets that the central bank will lift rates by just a quarter of a percentage point, a smaller increase than they were earlier anticipating. In addition, investors expect interest rates to reach 4.85 percent next year, down from expectations of more than 5 percent last month, futures contracts indicated on Tuesday.
“The pieces are falling into place for the Fed to pause rate hikes early in 2023,” said Rob Temple, chief market strategist at Lazard.
What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today. It is typically expressed as the annual change in prices for everyday goods and services such as food, furniture, apparel, transportation and toys.
Overall inflation measured by the Consumer Price Index rose 7.1 percent in November, from a year ago, compared with economists’ expectations of a gain of 7.3 percent and down from a gain of 7.7 percent in October.
The report is a welcome sign for investors after a mixed bag of economic data in recent weeks have delivered signals that suggest inflation may remain stubbornly high, weighing on markets.
A gauge of wholesale prices showed inflation rising more than expected last month. The job market also remains resilient, putting pressure on prices: Employers added 263,000 jobs in November — more than economists expected.
At the same time, a rise in the markets make the Fed’s job harder because it enriches investors and stimulates the economy, the opposite of what central bankers are trying to do to bring down inflation.
The yield on the U.S. two-year Treasury note, which closely tracks expectations for Fed rate moves, also fell on Tuesday, to about 4.23 percent, as investors dialed back expectations for how high the Fed will ultimately raise rates. The yield on the 10-year Treasury note was also lower, falling to about 3.51 percent.
As the Fed has continued its campaign to increase rates to bring down inflation, the yield on the two-year bond has risen well above the 10-year equivalent, a rare but reliable sign that investors in the bond market are expecting the economy to slip into a recession.
“I think inflation is coming down because growth is slowing and that will be a problem. But that’s not this week’s concern,” said Peter Tchir, head of macro strategy at Academy Securities.
For investors, the debate will now shift from the size of rate increases to how long the Fed will keep interest rates elevated, with investors eager for clues when central bankers meet on Wednesday.
Understand Inflation and How It Affects You
The inflation report and the Fed meeting “will undoubtedly set the tone for financial markets as we head into next year,” economists at Deutsche Bank wrote in a research note on Friday.
“This was universally good from an inflation standpoint,” Mr. Tchir said. It’s moving in the right direction.”
Elsewhere, Tesla slumped by 4.1 percent to $160.95, hitting a fresh low for the year. The company has fallen more than 60 percent from its peak in 2021.
Stocks in Europe jumped on Tuesday. The EuroStoxx 600 index climbed 1.3 percent, as did the Dax index in Germany.
Crude oil prices were also higher. Brent crude, the international benchmark, rose over 3 percent to settle above $80 for the first time in a week. West Texas Intermediate, the U.S. oil benchmark, rose 3 percent to $75.39.
Joe Rennison contributed reporting.