Equity markets have responded positively to the recent inflation data, showing substantial gains that have extended throughout the week. The pessimistic crash risk scenario presented by short sellers in late October now appears distant, and overall sentiment has shifted following the latest Federal Open Market Committee (FOMC) meeting. Additionally, more convincing downward trends in inflation contribute to the plausibility of a soft landing scenario.
Despite the mechanical fulfillment of expectations in the gap higher in equities on Tuesday after the Fed signaled a pause in interest rate hikes, it’s crucial to recognize that the battle against dampening inflation is ongoing. The Consumer Price Index (CPI) still maintains levels well above those seen before the pandemic, and the costs of non-discretionary consumption are considerably higher compared to just a year ago. Housing costs, a significant contributor to core inflation, rose by 0.3% on a monthly basis and have increased by 6.7% over the past year.
From the market’s perspective, the trend is toward decreasing inflation and easing cost pressures, supporting corporate profits. With interest rates likely at their peak in the current economic cycle, there’s improved visibility in the cost of credit, and the financial liquidity impulse remains robust.
Despite the largest series of interest rate hikes in four decades, the current U.S. economic condition remains robust, with GDP growing at 2.9% year over year in the third quarter. Employment growth remains strong, and unemployment is low at 3.9%. The fiscal deficit, nearly 6% of GDP, has played a significant role in offsetting the impact of tighter monetary policy and the decline in household savings.
Given the backdrop of a Fed pause, strong economic tailwinds, and improving corporate profit conditions, there’s potential for near-term upward trends in the equity market.
The chart below also shows the increasing participation rate that has occurred during the recent few weeks.
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