Wall Street rises on bets inflation won’t derail US Fed cut

The outlook for job seekers has taken a turn for the worse, according to respondents to a monthly survey from the Fed Bank of New York

Wall Street piled into bets the Federal Reserve will cut rates next week, with stocks rising on speculation that policy easing at a time when the economy is not in a recession will keep powering Corporate America.

Following a mild drop in the aftermath of weak jobs figures, the S&P 500 bounced. While upcoming data is projected to show progress on reducing inflation has stalled, traders continued to brace for almost three Fed cuts this year starting in September. Treasuries saw small gains, with the two-year yield remaining at the lowest since 2022. The dollar edged down.

“After last week’s tepid jobs numbers, it will likely take a major upside surprise from this week’s inflation data to derail a Fed rate cut next week,” said Chris Larkin at E*Trade from Morgan Stanley. “With rate cuts increasingly baked into forecasts, the market may be less inclined in the near term to shrug off additional signs of a slowing economy.”

The outlook for job seekers has taken a turn for the worse, according to respondents to a monthly survey from the Fed Bank of New York. At the same time, median expectations for consumer price increases one year ahead ticked up to 3.2%. That’s the highest since May.

In the countdown to next week’s Fed meeting, Thursday’s core consumer price index is projected to show a 0.3% increase in August for a second month. Before that, figures from the Bureau of Labor Statistics on Tuesday will likely underscore another US jobs markdown that will set the stage for a Fed cut.

“While the Sept. 5 report showed job growth had slowed, it doesn’t appear to be signaling a recession,” according to Invesco Global Market Strategy Office. “Slower growth, anchored inflation expectations, falling yields, and anticipated rate cuts point to an optimistic outlook for stocks.”

This month could defy the usual seasonal weakness in equities. While the S&P 500 has fallen 1% on average during Septembers going back to 1971, it has gained 1.2% in the month when the US central bank was reducing borrowing costs and the economy was not contracting, according to Bloomberg Intelligence.

Historically, in the two years following the start of a non-recessionary rate-cutting cycle, the median S&P 500 has climbed as much as 50%, according to Jim Reid at Deutsche Bank AG. By contrast, returns are far more muted when cuts coincide with recessions.

“That helps explain why equities are generally welcoming the prospect of Fed easing after a nine-month pause,” he said. “Recession probabilities are still relatively low, but the latest labor market data injects a dose of caution given payroll growth has slowed to a crawl.”

Soft Landing

The hope, Reid notes, is that these rate cuts will help pre-empt any downturn, keeping us on the soft-landing path.

Morgan Stanley’s Michael Wilson expects further gains in US equities even if moves turn more choppy in the near term. He reiterated that the US economy is transitioning to a so-called “early cycle” stage, which would support a “durable and broad” earnings recovery.

The record-breaking rally in US stocks is set to extend as laggards including small caps play catch-up amid a resilient economic outlook, according to Goldman Sachs Group Inc. strategists led by David Kostin.

A weaker-than-expected jobs report last week stirred worries among investors that the central bank has waited too long to reduce borrowing costs. RBC Capital Markets strategist Lori Calvasina said the soft data was raising uncertainty in a stock market that’s “priced for perfection.”

“Aggressive rate cuts are coming,” said Dennis DeBusschere at 22V Research. “That might change if labor-market data firms over the coming quarters. A series of rate cuts to end 2025 and persistently easy financial conditions should be expected. The bar to change to rate cut expectations through year-end 2025 seems high. “

Assuming economic activity holds up, easy financial conditions are a support for markets, he said, adding that his S&P 500 fair value framework points to 7,000. The index is currently hovering near 6,500.

The government will release its latest consumer price index Thursday. Core CPI, a measure of underlying inflation excluding food and fuel, probably rose 0.3% in August for a second month, according to the Bloomberg survey median estimate.

“Secondary indicators of inflation have shown some upward pressure, so the market is clearly more concerned with these indicators coming in hot. How hot is the question?” Bespoke Investment Group strategists.

“While a September cut next week is likely a done deal, the pace of cuts moving forward from there will hinge in large part on how ‘bad’ the inflation data is,” they said. “Come Thursday morning, the market will either be only thinking about stagflation or three cuts between now and year-end.”

To Mark Haefele at UBS Global Wealth Management, there’s little to prevent the Fed from cutting rates at this month’s meeting. And that would likely kick-start a run of 100 basis points in reductions over the next four meetings, from September to January, he said.

“Against this backdrop, we continue to recommend high-quality fixed income, where investors can lock in yields above those available on cash and benefit from potential capital gains if policy becomes more accommodative,” he said.