The U.S. stock market marked its two-year bull run on Saturday, with the Dow Jones Industrial Average and the S&P 500 closing the week at record highs. Despite ongoing concerns about inflation and uncertainty over the Federal Reserve’s upcoming interest rate cuts, analysts believe stocks could continue to rise.
Since hitting a bear market low of 3,577.03 on October 12, 2022, the S&P 500 has surged by more than 60%, according to Dow Jones Market Data. This swift rally has outpaced many analysts’ expectations, forcing Wall Street firms to repeatedly raise their year-end forecasts.
Recent inflation data, however, has raised questions about the Fed’s next move. A stronger-than-expected Consumer Price Index (CPI) report for September, along with robust job growth, has left some investors doubtful that the Fed will reduce rates in its November meeting. The CPI rose by 0.2% in September, slightly above the forecasted 0.1%, while core CPI (excluding food and energy) increased by 0.3%, surpassing expectations.
Although the stock market responded calmly to the CPI report, strategists are still keeping an eye on inflation expectations, particularly as the Fed’s next policy decision looms. José Torres, senior economist at Interactive Brokers, warned that October’s inflation data could be more concerning, as it will reflect the impact of the Middle East oil spike and strikes in key industries like Boeing.
Fed funds futures still indicate an 87.9% probability of a 25-basis-point rate cut in November, though this is down from 97.4% the previous week. Inflation expectations, as measured by the difference between five-year Treasury yields and five-year inflation-protected securities, have also been rising, now hovering around 2.3%.
Some market watchers, like Thierry Wizman and Gareth Berry from Macquarie, are monitoring whether these inflation expectations climb further, which could prompt the Fed to reconsider its rate-cut plans. A rise in breakevens to 2.5% could potentially derail any rate reductions in November.
In addition to inflation concerns, there is growing skepticism about how low the Fed will ultimately take interest rates in this easing cycle. Many analysts, including JoAnne Bianco of BondBloxx Investment Management, anticipate that the Fed will maintain rates closer to 3%, far above the near-zero levels seen at the start of 2022. Other experts, like Damian McIntyre from Federated Hermes, suggest rates could stabilize between 3% and 4%, depending on how inflation evolves in the coming months.
While inflation may keep rates elevated, stock market performance may not necessarily suffer. Torres noted that stocks could still thrive if the Fed remains dovish and tolerates higher inflation, as earnings-per-share growth often benefits from inflation when profit margins remain stable.
The Fed’s cautious approach to preventing a recession has also helped ease concerns about a potential economic downturn. With the central bank already cutting rates by 50 basis points in September, it appears policymakers are focused on preventing a spike in unemployment.
Looking ahead, analysts expect the stock market to remain strong over the next few months, particularly with the seasonal boost that often accompanies November and December. The Dow Jones ended last week up 1.2%, closing at a record 42,863.86, while the S&P 500 gained 1.1%, finishing at 5,815.03. Investors will be keeping an eye on key economic data this week, including initial jobless claims, retail sales, and housing starts.
