The stock market’s stiffest headwind, a surge in Treasury bond yields, was blown aside Wednesday by a surprisingly benign inflation report, which could rekindle bets on multiple Federal Reserve rate cuts before year-end.
Stocks stalled their two-year bull run in late December after a year-long rally added around $18 trillion to the market value of the S&P 500. The stall had followed a hawkish Fed inflation outlook and uncertainty tied to the broader economic agenda of President-elect Donald Trump.
Those factors, as well as the uplift from a solid domestic economy and a surprisingly resilient job market, added further downside pressure to U.S. Treasury bonds over the final weeks of December and into the new year. Analysts were flagging concern that benchmark 10-year note yields might test the 5% threshold for the first time since 2007.
Stubborn inflation pressures, meanwhile, as well as renewed concern about U.S. debt levels and planned immigration and tariff policies from the new Trump administration, also gave rise to nascent bets that the Fed might have to raise its benchmark borrowing rate this year.
Bond traders are seeing the biggest decline in real 10-year yields, a key market metric, since late 2023.
That sentiment was wiped out, however, when a surprising December inflation report showed the first downtick in core pressures since July, and underlying readings suggested that the Fed was finally getting a grip on both sides of its employment and price-stability mandate.
Inflation getting ‘pushed out of the system’
“Core Inflation isn’t accelerating and that’s the story,” said Jamie Cox, managing partner for Harris Financial Group. “The market may have had its hair on fire about inflation running away again, but the data do not support that conclusion.”
“What we are seeing is the typical ebb and flow of the data as inflation is being pushed out of the system,” he added.
Prior to the December inflation report investors had worried that the much stronger-than-expected jobs report would stoke price pressures deeper into 2025, with Trump policies on tariffs and immigration further fanning those inflation flames.
Related: Bonds hammer Fed rate cut bets as inflation greets Trump White House
“The Fed is likely to slow the pace of rate cuts in 2025 with inflation’s progress looking less clear,” said Bill Adams, chief economist at Comerica Bank in Dallas.
“Higher tariffs would raise the prices consumers pay for manufactured goods, and tighter immigration policies could tighten the job market and fuel a rebound in labor-cost pressures,” he added.
But while debt and deficit levels remain a keen market concern — particularly following data showing a record fiscal-first-quarter shortfall of $711 billion — Wednesday’s inflation report is sparking relief rallies across a host of financial markets.
Stocks surge as Treasury yields slide
U.S. stocks are on pace for their best gains since November, with the S&P 500 rising 1.75% to the highest levels since Jan. 6 and the rate-sensitive Nasdaq surging more than 440 points, or 2.3% in mid-day Wednesday trading.
Benchmark 10-year Treasury note yields, meanwhile, tumbled 11 basis points to 4.655%, with 2-year note yields falling to 4.291% as traders realigned their Fed rate forecasts for the coming months.
FedWatch, CME Group’s real-time tracker of Fed rate-betting, puts the odds of a June rate cut at around 65%, with projections split between a quarter-point and half-point reduction from the current level of 4.375%.
Bets on a follow-on move in September are essentially a coin-flip, with the odds increasing modestly over the final two meetings of 2025.
Related: Inflation report shock upends Federal Reserve rate bets heading into 2025
The change in Fed rate forecasts is also sparking the biggest decline in real 10-year rates, which track the difference between the actual yield and inflation projections, since 2023.
“We are watching 10-year U.S. Treasury yields very closely, and any further pullback would be a constructive tailwind for stocks and the S&P 500.” said Larry Tentarelli, chief technical strategist for Blue Chip Daily Trend Report.
Bulls look to earnings to extend gains
That’s leaving analysts a lot more bullish than they were just a few days ago, especially following a series of stronger-than-expected fourth-quarter earnings from the banking sector lead by blowout profits from Goldman Sachs (GS) .
The solid start to the earnings season is underscoring the market’s forecast for collective S&P 500 profits to grow by around 9.5% from the prior-year period to around $520 billion.
LSEG data suggest collective S&P 500 earnings will rise to $275 a share this year, a 14.2% advance from 2024, with tech and financial stocks leading the near-term gains.
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“As long as the economy continues to grow, the labor market remains stable and companies are able to keep growing profits, we would be buying any dips,” said Chris Zaccarelli, chief investment officer for Northlight Asset Management in Charlotte.
“We understand the pushback that valuations are high — and we share those concerns — but history shows that bull markets don’t end because of higher valuations,” he added.
“They end because the economic cycle is cut short by too much leverage or exogenous shocks, and that is why valuation in and of itself is a poor indicator for market timing.”
Related: Veteran fund manager issues dire S&P 500 warning for 2025
