Stocks jump higher as Fed sees progress against inflation

NEW YORK (AP) – Wall Street on Wednesday jumped to its highest level since the summer after the Federal Reserve’s latest rate hike, which said it was finally seeing improvements in inflation.

The S&P 500 rebounded from an early 1% loss to 1.5% after Fed Chair Jerome Powell said the economy was on track to bring inflation down following a series of rate hikes. The Dow Jones Industrial Average also erased a decline early, rising 140 points, or 0.4%, to 34,226 at 3:47 p.m. Eastern time, while the Nasdaq Composite was up 2.5%.

As expected, the Fed raised interest rates by 0.25 percentage points to their highest level since late 2007. This is the smallest such hike in the Fed blizzard since March.

More important to the markets is where interest rates go next.

Much of Wall Street is hoping that the slowdown in inflation since the summer means the Fed will hike rates a bit more before pausing and then potentially cutting rates later in the year. Interest rate cuts can reduce the pressure on the economy and relieve investment prices.

The Fed’s Powell reiterated on Wednesday that “ongoing rate hikes” are needed to bring inflation down to the Fed’s target level. And he said it was far too early to declare victory over inflation.

But he also said, “We can now, I think for the first time, say that the disinflation process has started.” This got Wall Street to consider a future without rate hikes.

Higher interest rates try to wipe out inflation by slowing the economy and raising the prices of stocks and other investments. The Fed has already hiked its key federal funds rate to its highest level since 2007, in a range of 4.50% to 4.75%, from practically zero early last year.

At stake is the economy, which many investors believe is likely to take one of two paths: either a relatively short and shallow recession, or a much deeper and more painful one. Build-up hopes for the former helped shares rally into January for a strong start to the year.

“My base case is that without a really significant downturn or a really big rise in unemployment, the economy can return to 2% inflation,” he said. “That’s a possible outcome. I think many forecasters would say that’s not the most likely outcome, but I would say there’s a chance.”

He also said he foresees no rate cuts this year.

Others in the market are not so optimistic. A third path for the economy is also possible, said Rich Weiss, senior vice president at American Century Investments: one that happened in the 1970s when inflation flared up again after the Federal Reserve cut interest rates too soon.

“We’re heading into a recession one way or another, whether the Fed eases the brakes or not,” Weiss said. “So you might as well kill inflation while you’re doing it. I think it’s nonsensical to think that at just the right time, the Fed will magically take its foot off the foot and slide into a short and shallow downturn and the stock market will come out unscathed.”

One area driving expectations for the Fed is the labor market, which has remained resilient despite all the rate hikes over the past year. While strength there is helping workers, there are concerns it could result in excessive wage increases that will fuel inflation further.

Wednesday’s reports gave a mixed picture on recruitment. According to the ADP, private payrolls rose by 106,000 in January. That’s a slowdown from the 253k growth a month earlier, and it was well below the 170k economists were expecting.

But a separate US government report suggested more strength. Job vacancies rose to 11 million in December, better than the slowdown to 10.3 million expected by economists. The broader US jobs report will arrive on Friday.

Adding to the mixed picture of the economy was a report from the Institute for Supply Management that US manufacturing weakened more than expected last month. It was the third consecutive month of contraction.

Treasury yields fell as Powell spoke, indicating expectations of a looser Fed.

The two-year yield, which is trending in line with expectations for the Fed, fell to 4.08% from 4.21% late Tuesday. The 10-year yield, which helps set interest rates on mortgages and other major loans, fell to 3.39% from 3.51% late Tuesday.

A lackluster earnings report season also continues on Wall Street, with more mixed earnings reports arriving from large US companies.

Electronic Arts plunged 9.9% after issuing forecasts for upcoming earnings that fell short of Wall Street’s expectations. Analysts said some players may become more selective as the economy slows.

WestRock, a paper and packaging company, fell 14.1% after reporting weaker-than-expected earnings and sales for the most recent quarter. It has also trimmed its forecasts for this fiscal year citing uncertainty about the economy.

On the positive side was Advanced Micro Devices, which rose 12.7% even though its fourth-quarter profit fell 98% year over year. The results were better than analysts expected.

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AP business writers Joe McDonald and Matt Ott contributed.

Stan Choe, The Associated Press