S&P 500 Rallies after Powell Remarks Amid Increasing Bets on Lower Inflation Risks

The major U.S. stock indices soared on Wednesday, reversing earlier weakness after the Federal Reserve raised its target interest rate by the expected 25 basis points but comments from Chairman Jerome Powell were interest as less-hawkish by investors.

On Wednesday, the blue chip Dow Jones Industrial Average settled at 34096.06, up 6.92 or +0.02%. The benchmark S&P 500 Index finished at 4119.21, up 42.61 or +1.05% and the technology-driven NASDAQ Composite closed at 11816.32, up 231.77 or 2.0%.

Prices Fall after Fed Hikes Benchmark Rate as Expected

In its monetary policy statement, released along with the interest rate hike, Fed policymakers said the U.S. economy was enjoying “modest growth” and “robust” job gains, with policymakers still “highly attentive to inflation risks” as it seeks to tighten financial conditions and reign in high prices.

Stocks Rebound after Powell Fails to Spook Investors with Higher Rate Hike Remarks

Despite the Federal Reserve’s aggressive rate hiking campaign, the central bank has more work to do, according to Fed Chair Jerome Powell. He said the central bank could conduct a few more rate hikes to bring inflation down to its target range. He also added that inflation is easing in some areas of the economy but it’s too early for the Federal Reserve to say the battle’s been won, said Fed Chair Jerome Powell.

But those hawkish comments failed to scare investors, who have been pricing in the possibility of a rate cut by the Fed in the back half of the year.

This is where the disparity between the market and the Fed begins.

Powell said he doesn’t expect the Fed to cut rates this year. “Given our outlook, I don’t see us cutting rates this year, if our outlook comes true,” the Fed chair said.

Powell also said he was “not concerned” about the bond market implying one more cut before a pause, because some market participants are expecting inflation to fall faster than the Fed does.

“If we do see inflation coming down much more quickly, that will play into our policy setting, of course,” Powell said.

Bullish Price Action Suggests investors Believe Fed May Be Nearing End of Rate Hike Cycle

It may not have been bullish sentiment, a less-hawkish Powell or for that matter a more-dovish Powell that fueled Wednesday’s massive turnaround. It may have been that investors believe all the chatter means that the Fed is nearing the end of its interest rate hiking cycle.

Whether it’s in March at 4.75% that investors believe, or in June at 5.00% or higher that Fed policymakers have been preaching, investors believe the end is near.

Inflation Will Ultimately Determine When the Fed Stops Hiking Rates

Clearly investors like the long side at this time amid their interpretation of how fast inflation is falling and how quickly the Fed will reach its terminal rate or begin cutting interest rates. This means the market will continue to be data dependent.

Traders will be watching Friday’s Non-Farm Payrolls report closely for further signs of weakening in the labor market, but next week’s consumer inflation report will ultimately determine if inflation is on a path toward the Fed’s mandated 2% level.

We may be moving toward that level, but we’re not close enough for the Fed to be comfortable. Furthermore, any uptick in inflation and the current rally could come crashing down.