October inflation data is 'nirvana' for stock market bulls

Stocks ripped higher on Tuesday after October's inflation data bolstered investor confidence the Federal Reserve is done raising interest rates for this cycle.

The tech-heavy Nasdaq posted its best day since April and the small-cap Russell 2000 (^RUT) popped more than 5%, its best single-day performance in more than a year. The interest rate-sensitive Real Estate sector (XLRE), another 2023 laggard, popped more than 5% too, also marking its best day since November 2022.

"With the US economy holding up, the inflation data are soft-landing nirvana for the equity markets," Renaissance Macro head of economics Neil Dutta wrote in a note on Tuesday.

For stock market bulls, however, the action in the bond market on Tuesday might've been more significant.

Treasury yields, a noted cloud hanging over investor sentiment since August, tumbled. The 10-year Treasury yield (^TNX) fell 18 basis points, its largest move since March. On Tuesday, the 10-year yield closed at 4.44%, its lowest level since Sept. 22.

"The market's telling you they expect the Fed to start easing sooner rather than later," Charles Schwab chief fixed income strategist Kathy Jones told Yahoo Finance in an interview. "I would guess early 2024."

Read more: What the Fed rate-hike pause means for bank accounts, CDs, loans, and credit cards

The latest Consumer Price Index (CPI) released Tuesday showed prices were unchanged month over month, while "core" inflation rose at the slowest annual rate since September 2021.

Both numbers showed inflation pressure easing faster than economists had expected.

A 'buy the dip' market

A soft landing, in which inflation falls back towards the Fed's 2% target without the economy falling into recession, is what Fed Chair Jerome Powell calls the central bank's "primary objective."

Recent data has pointed to an economy headed down that path.

Tuesday's decrease in inflation follows a jobs report that showed the labor market is growing at a slower rate while the most recent GDP report revealed the economy grew at its fastest pace in nearly two years during the third quarter.

And the more confidence builds among investors that the Fed is done raising rates, the more pressure eases off the "pain trade" that has plagued stocks for months.

"The Treasury market certainly feels more like a 'buy the dip' than 'sell the rally' market now," Jones said.

"Over a long time, there has been so much fear of rising yields and falling prices. And now, I have a perception that there's a lot more people saying, 'Well, where do I get in?' If I didn't get 5% on my Treasury [bond], where do I go now to get it?"

Jones's view that a more durable rally has broken out in bonds squares with new survey data from Bank of America out Tuesday, which showed investors are increasingly confident yields will fall in 2024.

For stock market bulls like Tom Lee, head of research at Fundstrat, Tuesday's report also served as a pivot point in what has been a somewhat tentative rally in the stock market. To Lee, the key to Tuesday's report was the number of categories not seeing prices rise.

Just seven of the 31 core components in the CPI report rose compared to the prior month, a sign to Lee that inflation could be "hitting a wall."

"This should drive a change in both Fed's view of the 'stickiness' of inflation and also the market narrative," Lee wrote.

Still, Jones expects things could still be "rocky" in the fixed-income markets in the months ahead.

"I don't think it's a smooth glide path," Jones said. "It never is, but especially in this cycle because it's been such an odd cycle. But ... if we continue to get decent news, if the trends continue, then [yields falling] is what I would expect."

Josh Schafer is a reporter for Yahoo Finance.

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