Stocks rise after Fed acknowledges "disinflationary process"

Stocks swung to gains on Wall Street following the latest hike to interest rates by the Federal Reserve, which said it's finally seeing improvements in inflation. 

The S&P 500 rallied after an early 1% loss and rose 43 points, or 1.1%, to close at 4,119. The Dow Jones Industrial Average also erased an early to drop to rise 7 points, or less than 0.1%, to 34,092. The Nasdaq composite jumped 2%.

The Federal Reserve extended its fight against high inflation Wednesday by raising its key interest rate by a quarter-point, its eighth consecutive hike since March. It's the smallest such increase in the Fed's blizzard of rate hikes since it began almost a year ago. The Fed signaled that even though inflation is easing, it remains high enough to require further rate hikes.

What's more important for markets is where interest rates are heading next.

Hikes not over

"We will need substantially more evidence to be confident that inflation is on a long, sustained downward path, Powell said at a news conference.

"It would be very premature to declare victory or think that we really got this," Powell added. "We have to complete the job."

But he also said, "We can now say, I think for the first time, that the disinflationary process has started." That got Wall Street thinking about a future with no more rate increases.

"The Fed is confirming they are near the end of the hiking cycle," Bill Adams, chief economist for Comerica bank, said in a note about today's Fed decision, pointing to the Fed's focus in its latest guidance on the "extent of future increases."

"Previous statements said these factors would influence the 'pace' of future increases," Adams said.

Echoing those thoughts, Jeffrey Roach, chief economist for LPL Financial, said in an email that "the days of any hikes greater than 25 bps are over for this cycle." Said Roach,"It seems the Committee no longer worries about the "pace" but now focused on the 'extent' of future increases." 

Slowdown in wage increases

Over the past year, with businesses sharply raising pay to try to attract and keep enough workers, Powell has expressed concern that wage growth in the labor-intensive service sector would keep inflation too high. Businesses typically pass their increased labor costs on to their customers by charging higher prices, thereby perpetuating inflation pressures.

But recent gauges show that wage growth is slowing. The Fed's hike was announced one day after the government reported that pay and benefits for America's workers grew more slowly in the final three months of 2022, the third straight slowdown. That report might help reassure the Fed that wage gains won't fuel higher inflation.

And in December, overall inflation eased to 6.5% in December from a year earlier, down from a four-decade peak of 9.1% in June. The decline has been driven in part by cheaper gas, which has tumbled to $3.50 a gallon, on average, nationwide, from $5 in June.

Supply-chain backups have also largely been cleared, leading to a drop in prices for manufactured goods. Used car prices, having skyrocketed in the pandemic amid an auto shortage, have now fallen for several months.

Economy at stake

At stake is the economy, which many investors see likely heading down one of two paths: either a relatively short and shallow recession or a much deeper and more painful one. Building hopes for the former helped stocks rally through January to a strong start of the year.

"My base case is that the economy can return to 2% inflation without a really significant downturn or really big increase in unemployment," Powell said. "That's a possible outcome. I think many forecasters would say it's not the most likely outcome, but I would say there's a chance of it."

He also said he did not foresee cutting rates this year.

Others in the market are not as optimistic. A more ominous pathway for the economy is also possible, said Rich Weiss, senior vice president at American Century Investments: one that happened during the 1970s where inflation reignited after the Federal Reserve let up on interest rates too soon.

"We're headed into a recession one way or the other, whether the Fed eases up on the brakes or not," Weiss said. "So you might as well kill inflation while you're doing it. I think it's nonsensical to think the Fed is going to magically take their foot off at exactly the right time and slide into a short and shallow downturn and the stock market will come through unscathed."

One area influencing expectations for the Fed is the job market, which has remained resilient despite all of last year's rate hikes. While strength there helps workers, a worry is that it could lead to too-high gains in wages that give inflation more fuel.

Hiring landscape unclear

Reports on Wednesday gave a mixed picture on hiring. Private payrolls rose by 106,000 in January, according to ADP. That's a slowdown from growth of 253,000 a month earlier, and it was well below the 170,000 that economists expected.

But a separate report from the U.S. government indicated more strength. It said the number of job openings increased to 11 million in December, better than the slowdown to 10.3 million that economists expected. The more comprehensive report on the U.S. job market will arrive on Friday.

Adding to the mixed picture on the economy was a report from the Institute for Supply Management, which said U.S. manufacturing weakened by more than expected last month. It was the third straight month of contraction.

Treasury yields fell as Powell spoke, an indication of expectations for an easier Fed.

The two-year yield, which tends to track expectations for the Fed, fell to 4.08% from 4.21% late Tuesday. The 10-year yield, which helps set rates for mortgages and other important loans, fell to 3.39% from 3.51% late Tuesday.

A lackluster earnings reporting season also continues on Wall Street, with more mixed profit reports arriving from big U.S. companies.

Electronic Arts tumbled 9.9% after it gave forecasts for upcoming results that fell short of Wall Street's expectations. Analysts said some gamers may be getting more selective given the softening economy.

WestRock, a paper and packaging company, dropped 14.1% after it reported weaker earnings and revenue for the latest quarter than expected. It also axed its forecasts for this fiscal year, citing uncertainty about the economy.

In:
• Jerome Powell
• Inflation
• Federal Reserve
• United Kingdom