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Inflation finally falls, extending markets’ winning streak

Markets have been on a hot streak, however muted, with equities pulling ahead for six consecutive days as data shows inflation has died down.

MANHATTAN (CN) — Wall Street pulled down decent gains for the second consecutive week, building on its strong start to 2023 with help from data that show inflation has started to fall and in spite of recession warnings from big banks.

The good news caused the Dow Jones Industrial Average to gain 672 points since last Friday, while the S&P 500 netted 104 points and the Nasdaq increased by 510 points. Dark clouds seem to be rolling in, however, as the first round of earnings from financial institutions hint a recession is around the corner.  

On Thursday, a key inflation report by the U.S. Bureau of Labor Statistics nudged Wall Street into positive territory. The agency’s consumer price index showed a 0.1% decline in prices last month, the first monthly drop since 2020, which now puts inflation at 6.5% over the last year after peaking at 9.1% annualized back in June.

The biggest drop came in energy, which have seen a 20% decline in prices over the last six months and fell 4.5% in December. Gasoline fell 9.4% last month while fuel oil dropped a whopping 16.6%. Other sectors also saw notable decreases. Used vehicle prices also dropped notably, declining 2.5%, while airfares fell by 3.1%.

One notable increase in prices was in services, which actually increased by 0.5% last month following a 0.4% increase. The main driver there was shelter costs, which bumped up 0.8% last month after a 0.6% increase in November. Experts say house price indices and market rents typically lag other sectors, however, and the December increase probably reflects the hot housing market from early 2022.

The drop in prices follows a meager 0.1% increase from November, which now makes it a real trend that inflation is falling, though prices flatlined last July and August. Investors have eagerly awaited a steady drop as it will likely correspond to a moderation in interest rate hikes from the Federal Reserve.

“It will be interesting to see if the markets can hold the recent rally,” said Gina Bolvin, president at Bolvin Wealth Management in Boston. “Previously when we had good inflation data, the Fed came out with hawkish comments to bring the market down. However, we expect the Fed to pause [interest rate increases] this spring and we expect core inflation to be below 3% by year end.”

Most expect the Fed will continue to raise interest rates during its next meeting in February, though some think the latest data could persuade the central bank to increase rates by only 0.25% instead of half a percentage point.

“Year-over-year inflation is still far above 2% and the unemployment rate is at a half-century low, so the Fed will probably keep raising rates in early 2023, but by much less than in 2022,” said Bill Adams, chief economist at Comerica. “But the Fed’s turn may come too late to prevent a recession.”

Many large financial institutions are already banking on a recession. Earlier this week, reports that Goldman Sachs plans to cut 3,200 jobs harkens back to the last time the investment bank laid off so many employees: the Great Recession in 2008.

Other Wall Street firms released their earnings reports this week, which also indicate an inevitable recession. In its quarterly release, JPMorgan Chase beat forecasts with revenue of $35.57 billion, but it also set aside $2.3 billion for potential losses this coming quarter. The firm said that set-aside is “driven by a modest deterioration in the firm’s macroeconomic outlook, now reflecting a mild recession in the central case.”

In comments to investors, CEO Jamie Dimon said “we remain vigilant and are prepared for whatever happens, so we can serve our customers, clients, and communities around the world across a broad range of economic environments.”

Bank of America also beat forecasts, though just barely, with revenue of $24.66 billion in its earnings release. It also increased its provision for credit losses from $1.1 billion to $1.6 billion. During a call with investors, CEO Brian Moynihan said that the bank’s “baseline scenario contemplates a mild recession,” and that the worst-case scenario is for unemployment to increase to 5.5% in 2023.

“While 2023 is set to be a poor year for the global economy, recent events suggest that the risks around the outlook have become less skewed to the downside,” Ben May, director for global macro research at Oxford Economics, wrote in an investor’s note on Wednesday, adding that “the non-appearance of further upside surprises is welcome news after the events of the past twelve months or so.”

May added that the risk of energy rationing in Europe this winter has subsided, and a weakening U.S. dollar has lessened the risk of central banks abroad from overtightening to reinforce their own currencies.

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