The stock market is staging its biggest rally in two years after a report showed Thursday morning that inflation cooled in October.
The consumer price index showed that annual inflation slowed to 7.7% in October, down half a percentage point from September. The extent of the slowdown surprised investors and increased confidence that the Federal Reserve will begin to slow its campaign to curb inflation via interest rate hikes.
The prospect of looser money boosted stock valuations. As of midday, the Dow Jones Industrial Average was up by more than 1,000 points, or about 3%. The tech-heavy Nasdaq soared by more than 6%, and the S&P 500 grew by some 4.5% in the hours after the jobs report dropped — the biggest one-day gain since April 2020.
The market’s sigh of relief was also captured by the Chicago Board Options Exchange Volatility Index, better known as the VIX but also as the “fear index.” The VIX was down nearly 12% on Thursday — although it is still up nearly 40% since the start of the year.
The Fed has raised rates by a mammoth 75 basis points at its last four meetings — a historic scale that is akin to 12 conventional rate hikes. Because inflation came in a bit cooler than predicted, it now appears likely that the Fed will only raise rates by 50 basis points at its December meeting.
Investors are now pegging the odds of another three-quarters hike at just over 19% and pricing in about an 81% chance of a 50 basis point hike, according to CME Group’s FedWatch tool, which calculates the probability using bond market futures prices. Just a day ago, the odds of a 75 basis point increase were as much as 43%.
Some Fed presidents have begun to message that they would support the gradual lessening of rate hikes should inflation keep heading down, albeit slowly.
“I have always thought that … as we got closer to the place where we judged we were sufficiently tight, that smaller increments would make the most sense,” Boston Fed President Susan Collins told the Wall Street Journal last week.
On Thursday afternoon, though, Cleveland Fed President Loretta Mester, while not addressing the report directly, threw a bit of cold water on investors’ optimism that rate hikes are winding down. During a webcast appearance, she reiterated that rates will need to continue to be hiked until inflation is crushed.
“Given the current level of inflation and the fact that it’s broad-based and it’s been persistent … I think monetary policy is going to need to become more restrictive and remain restrictive for a while in order to put inflation on a sustainable downward path to 2%,” Mester said.
The odds of a recession, while still likely, decreased a bit with Thursday’s report.
Economic modeling by Bloomberg, which was released last month, assigns a 100% chance of a recession occurring by next October. That is up from 65% for the same period of time in the previous iteration of the model.
Last month the Conference Board, based upon its probability model, also predicted a 96% chance of the U.S. economy entering into a recession in the next 12 months. Additionally, the group sees the last quarter of 2022 and the first quarter of 2023 as likely to experience negative real GDP growth rates.