Messy inflation reports do little to dissuade Fed rate cut hopes

MANHATTAN (CN) — Markets had one of their best weeks of the year, with two of the three indices again setting new record highs.

Muddy inflation data from last week did little to deter equities from rising, with the Dow Jones Industrial Average steadily gaining each day until Friday, ultimately gaining 761 points for the week and setting a new high point of 39,781 on Thursday.

The S&P 500 and Nasdaq also set new records, with the former gaining 117 points this week to settle at 5,234, and the latter increasing 455 points to finish at 16,428.

The main driver for markets this week was the Federal Reserve, which on Wednesday kept interest rates steady at the 5.25% to 5.5% range for the fifth consecutive meeting. The Fed’s “dot plot,” which charts each member’s prediction on interest rates, still predicts three rate cuts and for the federal funds rate to hit 4.5% to 4.75% by the end of the year.

Following the meeting, Fed Chair Jerome Powell noted the central bank was concerned about recent resurgent inflation data but tried to assure investors that “the story is really essentially the same” in terms of the Fed’s goal of cutting rates if inflation drops to the 2% average target.

“I don’t think we really know whether this is a bump on the road or something more,” Powell told reporters. “Now here are some bumps and the question is, are they more than bumps?”

Powell said the nine months of 2.5% inflation should not be canceled out by last month’s inflation reports, which showed an increase over 3% in the annualized consumer price index.

While investors initially began the year hoping the Fed might start cutting rates this month, that expectation has been pushed out to May and now June. Wall Street also has tempered its expectation on the total number of interest rate cuts from four to three this year.

“Consumer prices aren’t immune to seasonality issues,” Matthew Martin, economist at Oxford Economics, wrote in an investor’s note. “While the February rate remained elevated, we believe Fed officials will look past seasonal issues and conclude that enough disinflation is in the pipeline to being rate cuts soon.”

Earlier in the week, the U.S. Census Bureau reported that residential construction picked up last month, with housing starts increasing 10.7%, more than expected. Housing completions also increased to 19.7% in February and are up nearly 10% from a year ago.

More importantly, new permits — which are among the best indicators of future building activity — are on the uptick, indicating that residential activity should remain strong throughout 2024.

“Investors should know that demand for new homes remain fairly stable despite high borrowing costs,” said Jeffrey Roach, chief economist at LPL Financial. “Markets have rewarded investors aware of the opportunities in housing-related sectors.”

The overall economy is pointing upward, too, with the Conference Board’s leading economic index increasing by 0.1%, the first time it has increased since February 2022. Experts credit residential construction, manufacturing, and stock prices for the increase, but they also note the economy continues to face obstacles.

“Though the index points to continued growth headwinds, we still look for U.S. [gross domestic product] to grow by more than 2% in 2024 thanks to a consumer that will benefit from further moderation in inflation, a strong labor market, and solid household balance sheets,” wrote Bernard Yaros at Oxford Economics.

Follow @NickRummell

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