U.S. stocks soar to 3-month high as inflation falls in July

Stocks closed at three-month highs on Wall Street Wednesday as investors cheered a report showing inflation cooled more than expected in July.

The S&P 500 jumped more than 2% Wednesday on expectations that slower inflation will mean the Federal Reserve won’t hike interest rates as much as feared.

Technology stocks, cryptocurrencies and other investments among the year’s biggest losers due to the Fed’s aggressive rate hikes led the way. Treasury yields pulled back sharply following the inflation data, as traders pared their bets for how much the Fed will raise interest rates at its meeting next month.

The S&P 500 rose 88 points to close at at 4,210, amid a widespread rally that launched after a report showed the nation’s biggest economic challenge, inflation, slowed to 8.5% from 9.1% in June. Technology stocks, cryptocurrencies and others of the year’s hardest-hit investments were some of the day’s biggest winners.

The Nasdaq Composite, whose many high-growth and expensive-looking stocks have been particularly vulnerable to interest rates, was up a market-leading 2.9%, while the Dow Jones Industrial Average ended the day flat. Bitcoin rose 3.3% to top $24,000.

Netflix, a formerly high-flying and high-growth stock that has plunged to be this year’s worst in the S&P 500, was up 5% though it remains down by nearly 60% for 2022.

Rising hopes on cooling inflation

Much of July’s slowdown in inflation was due to lower prices for gasoline and oil. But even after ignoring pump prices and volatile food prices, so-called core inflation held steady last month instead of accelerating as economists had forecast.

The data encouraged traders to scale back bets for how much the Fed will raise interest rates at its next meeting. They now see a hike of a half percentage point as the most likely outcome, according to CME Group. A day earlier, they were betting on a more aggressive hike of 0.75 percentage points, the same as the last two increases.

Such differences may not sound like much, but interest rates help set where prices go across financial markets. And higher rates tend to pull down prices for everything from stocks to commodities to crypto.

Still, while the news of cooling inflation has energized markets, it likely won’t deter the Fed from continuing to raise interest rates in a bid to contain inflation, analysts say.

“Even though the core aggregate slowed down a lot from the previous month, Fed officials are unlikely to see this report as a signal to deviate from their steep tightening path we foresee through the end of this year,” researchers at Morgan Stanley wrote in a report.

Prices for bonds soared immediately after the inflation report’s release, pulling their yields lower. The yield on the two-year Treasury, which tends to track expectations for the Fed, fell to 3.10% from 3.27% late Tuesday.

The 10-year yield sank more slowly, down to 2.74% from 2.78%, narrowing how far it is below the two-year yield. Many investors see such a gap as a fairly reliable signal of a coming recession.

Recession worries have built as the highest inflation in 40 years squeezes U.S. households and businesses. The Fed and other central banks have been hiking rates to slow the economy in hopes of stamping out inflation, but they risk choking it off if they move too aggressively.

“This is a step in the right direction but keep in mind we have many miles ahead of us before inflation normalizes,” said Mike Loewengart, managing director, investments strategy, at E-Trade from Morgan Stanley.

The Fed will get a few more highly anticipated reports before its next announcement on interest rates September 21, which could also alter its stance. Those include reports showing hiring trends across the economy due September 2, and the next update on consumer inflation coming on September 13.

More immediately, reports this week will show how inflation is doing at the wholesale level and whether U.S. households are still ratcheting down their expectations for coming inflation, an influential datapoint for Fed officials.