Stocks and Bonds Rally on Lower Core Inflation
A moderate U.S. inflation report triggered a sharp relief rally in both stocks and bonds on Wednesday, as investors welcomed signs of easing price pressures. The consumer price index (CPI) for December rose at a faster-than-expected pace, but markets focused on the core CPI—which excludes volatile food and energy prices—rising just 0.2%, compared to 0.3% in the previous four months.
The S&P 500 surged 1.8%, while the 10-year U.S. Treasury yield reversed earlier losses and dropped to 4.66%, as bond prices rose.
“This reading beat expectations modestly, but traders pounce aggressively on any whiff of good news,” said Steve Sosnick, market strategist at Interactive Brokers. “It’s a number and a reaction that we have to view positively, although quite possibly it’s magnified by the negativity we’ve been battling.”
Market Uncertainty Lingers Over Fed Policy and Trump’s Policies
Despite the rally, investors remain cautious about the future of Federal Reserve interest rate policy and the impact of incoming President Donald Trump’s policies on inflation, tariffs, and taxes.
“The issues that have been driving rates higher and weighing on stocks are still out there,” said Art Hogan, market strategist at B. Riley Wealth. “We just don’t know whether we’ll see tariffs that are surgical or sweeping, what kind of policy moves we’ll see in other areas that could feed into inflation or growth.”
Fed officials acknowledged the heightened economic uncertainty in the coming months as they wait to assess the fiscal policies of the new administration.
Traders Adjust Rate Cut Expectations
Before the CPI report, there were murmurs that the Fed might even consider a rate hike, according to Jeff Weniger, head of equity strategy at WisdomTree Inc. However, the latest inflation data has shifted expectations toward a rate cut by June.
Following the report:
- Traders now see a 50% chance of a second Fed rate cut by year-end.
- Previously, markets had priced in only one rate cut for 2025.
Tina Adatia, head of fixed income client portfolio management at Goldman Sachs Asset Management, noted that the CPI report strengthens arguments for rate cuts, but “the Fed has scope to be patient.”
“More good inflation data will be required for the Fed to deliver further easing,” Adatia said.
Tariff and Trade Uncertainty Could Impact Inflation
Even with slowing inflation, market volatility is expected to persist, especially with potential changes in U.S. trade policy.
Rick Rieder, BlackRock’s chief investment officer of global fixed income, warned that Trump’s potential changes to tariffs and trade policy “hold the potential to increase core goods inflation for a time.”
Volatility Likely to Increase
The market remains data-dependent, and daily swings of 10 to 15 basis points in the 10-year Treasury yield could become the new normal, according to Kevin Flanagan, head of fixed income strategy at WisdomTree.
With traders still pricing in uncertainty over fiscal policy, inflation data will be closely watched in the coming months to determine whether further rate cuts will materialize in 2025.
Looking Ahead
While the latest inflation report provided temporary relief to markets, uncertainty surrounding fiscal policy, tariffs, and the Fed’s next moves will likely keep investors on edge.
The next major test will be upcoming economic data releases, which could determine whether the Fed moves ahead with rate cuts or maintains its cautious stance in the months ahead.
