Wall St roars after US inflation cools more than expected

Lower fuel prices have helped bring down inflation in the US. Photo / NZME

Wall Street roared overnight after inflation cooled more than expected last month, sparking speculation the Federal Reserve may not have to be as aggressive about hiking interest rates as feared.

The S&P 500 was 1.9 per cent higher amid a widespread rally that launched after a report showed the nation's biggest economic challenge, inflation, slowed to 8.5 per cent at the consumer level last month from 9.1 per cent in June. Technology stocks, cryptocurrencies and other of the year's hardest-hit investments were some of the day's biggest winners.

The Nasdaq composite, whose many high-growth and expensive-looking stocks have been particularly vulnerable to interest rates, was up a market-leading 2.5 per cent. Bitcoin rose 3.3 per cent to top US$24,000, and the Dow Jones Industrial Average was up 469 points, or 1.4 per cent, at 33,244, as of 1:34pm Eastern time.

Much of July's slowdown in inflation was due to lower prices for gasoline and oil. But even after ignoring that and volatile food prices, so-called "core inflation" held steady last month instead of accelerating as economists had forecast.

The data encouraged traders to scale back bets for how much the Fed will raise interest rates at its next meeting. They now see a hike of a half percentage point as the most likely outcome, according to CME Group. A day earlier, they were betting on a more aggressive hike of 0.75 percentage points, the same as the last two increases.

Such differences may not sound like much, but interest rates help set where prices go across financial markets. And higher rates tend to pull down prices for everything from stocks to commodities to crypto.

Prices for bonds soared immediately after the inflation report's release, pulling their yields lower. The yield on the two-year Treasury, which tends to track expectations for the Fed, fell to 3.14 per cent from 3.27 per cent late Tuesday.

The 10-year yield sank more slowly, down to 2.76 per cent from 2.78 per cent, narrowing how far below it is the two-year yield. Many investors see such a gap as a fairly reliable signal of a coming recession.

Recession worries have built as the highest inflation in 40 years squeezes households and corporations around the world. The Fed and other central banks have been hiking rates to slow the economy in the hope of stamping out inflation, but they risk choking it off if they move too aggressively.

"It's a very knife-edge type of path that they are trying to tread here," said Brian Nick, chief investment strategist at Nuveen.

To be sure, inflation is still painfully high, and the expectation is for it to stay so for a while. But the data yesterday nevertheless rejuvenated Wall Street, which staggered following a stronger-than-expected jobs report on Friday that raised expectations for a more aggressive Fed. It bolstered hopes that a peak in inflation — and thus in the Federal Reserve's most aggressive rate hikes — may be on the horizon.

"This is a step in the right direction but bear in mind that we have many miles ahead of us before inflation normalises," said Mike Loewengart, managing director, investments strategy, at E-Trade from Morgan Stanley.

The Federal Reserve will get a few more highly anticipated reports before its next announcement on interest rates on September 21, which could also alter its stance. Those include reports showing hiring trends across the economy due on September 2 and the next update on consumer inflation coming on September 13.

More immediately, reports this week will show how inflation is doing at the wholesale level and whether US households are still ratcheting down their expectations for coming inflation, an influential data point for Fed officials.