The main obstacle to the stock market, a sharp rise in Treasury bond yields, was pushed aside on Wednesday by a relatively mild inflation report, which may lead to renewed speculation that the Federal Reserve will cut interest rates multiple times before the end of the year.
The stock market’s two-year gain came to an end in late December after an almost year-long rise boosted the S&P 500’s value by approximately $18 trillion. The pause was preceded by the Federal Reserve’s more aggressive inflation outlook and concerns about President-elect Donald Trump’s economic plans.
Those factors, along with the boost from a strong domestic economy and a surprisingly robust labor market, put additional downward pressure on U.S. Treasury bonds during the final weeks of December and into the new year. Analysts were warning signs that yields on benchmark 10-year Treasury notes could potentially reach levels not seen since 2007 for the first time.
Stubborn inflation pressures, as well as renewed worries about the high levels of U.S. debt and new policies on immigration and tariffs by the Trump administration, are leading to early bets that the Federal Reserve may need to increase its benchmark interest rate this year.
That sentiment was erased, though, when a surprising December inflation report revealed the first decline in core pressures since July, and underlying readings indicated that the Fed was finally gaining control over both aspects of its employment and price-stability goals.
Inflation is being pushed out of the system.
What’s essential to note here is that core inflation isn’t accelerating, and that’s really the takeaway,” said Jamie Cox, managing partner for Harris Financial Group. “Although the market was worried that inflation would be spiraling out of control, the numbers just don’t indicate that’s happening.
The data reflects the normal fluctuation that occurs as inflation is being released from the economy.
Before the December inflation report, investors were concerned that the stronger-than-expected jobs report might add to higher prices next year, with Trump’s policies on tariffs and immigration possibly making inflation worse.
“The Federal Reserve is probably going to slow the pace of interest rate cuts in 2025 as inflation’s progress appears less certain,” said Bill Adams, chief economist at Comerica Bank in Dallas.
He noted that higher tariffs would increase the cost for consumers to purchase manufactured goods, and stricter immigration policies could lead to a tighter job market and renewed upward pressure on labor costs.
Although debt and deficit levels continue to be a significant worry in the market – especially after a recent quarterly fiscal loss of $711 billion – Wednesday’s inflation report is causing relief rallies across a range of financial markets.
Stocks shoot up as Treasury yields drop
U.S. stocks are on track for a significant gain, with the S&P 500 rising 1.75% to a level not seen since January 6, and the Nasdaq jumping more than 440 points, or 2.3%, in mid-day trading on Wednesday.
Benchmark 10-year Treasury note yields dropped 11 basis points to 4.655%, with 2-year note yields falling to 4.291% as market participants revised their Federal Reserve interest rate expectations for the coming period.
FedWatch, the CME Group’s real-time tracker of Fed rate betting, indicates a 65% possibility of a rate cut in June. This prediction is evenly weighted between a reduction of a quarter point and half point from the current interest rate of 4.375%.
Bets on a second move in September are essentially a toss-up, with the chances growing slightly over the final two meetings in 2025.
The shift in Fed rate forecasts is also causing the largest decline in real 10-year rates since 2023, which are based on the difference between the actual yield and inflation expectations.
“We’re keeping a close eye on 10-year U.S. Treasury yields, and any further drop in these yields would provide a positive boost to the stock market and the S&P 500,” said Larry Tentarelli, chief technical strategist for Blue Chip Daily Trend Report.
Bulls look to earnings to extend their gains
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The strong beginning to the earnings season is supporting the market’s prediction that S&P 500 profits will increase by approximately 9.5% from last year to approximately $520 billion.
According to LSEG data, it is estimated that collective earnings from the S&P 500 will reach $275 per share this year, representing a 14.2% increase from the 2024 figure, with technological and financial sector stocks expected to drive the majority of the near-term gains.
More Economic Analysis:
- Expectations of a 2025 federal interest rate cut are linked to unknown policy decisions made by the Trump administration.
- Inflation report complicates the odds of an interest rate cut.
- Trump’s plans will put next year’s Federal Reserve interest rate cut speculations to the test.
“As long as the economy keeps expanding, the job market stays steady, and companies are able to continue increasing their profits, we would buy any drops in stocks,” said Chris Zaccarelli, chief investment officer for Northlight Asset Management in Charlotte.
We see the worries about high valuations, and we agree with them, but past examples show that bull markets usually don’t end because of rising valuations.
They fall apart because the economic cycle is halted prematurely due to excessive borrowing or unexpected external events, and as a result, market valuation isn’t a reliable indicator for predicting the right time to invest.
