Wall Street got the inflation report it wanted Wednesday. Unfortunately, the bond market had other ideas.
The Federal Reserve’s preferred inflation gauge came in noticeably cooler than expected in August, reducing expectations for another interest-rate hike in October. But stubbornly high long-term Treasury yields, stronger-than-expected economic data and Friday’s looming jobs report kept investors from turning the good inflation news into a broad market rally.
By the closing bell, the Nasdaq managed a gain, while the Dow and S&P 500 finished lower. The Dow also ended both September and the third quarter in negative territory, snapping a five-month winning streak. Dow Snaps 5-Month Win Streak, Suffers Steep Q3 Slide
So was Wednesday’s inflation report really good news?
According to James Knightley of ING, there was plenty to like.
In Softer-Than-Feared U.S. Inflation Despite Robust Spending, Knightley notes that the core Personal Consumption Expenditures price index—the Fed’s favored inflation measure—rose just 0.2% in August, below the 0.3% consensus forecast. July’s increase was also revised down from 0.2% to 0.1%.
Even more encouraging, annual core inflation came in at 3%, compared with expectations for 3.3%. And while that's still well above the Fed's 2% target, the three-month annualized rate has now fallen to 2%.
The economy isn't exactly grinding to a halt in the process. Real consumer spending increased 0.6% in August, while second-quarter GDP growth was revised upward to 2.2%.
The report substantially reduced expectations for an October rate hike, seemingly giving investors the combination they've been hoping for: cooling inflation without an economic collapse.
But there's a rather large elephant in the room.
What Is the Bond Market Trying to Tell Us?
Long-term Treasury yields have been marching toward levels not seen in decades.
James Picerno takes up that question in Treasury Yields Keep Rising. Can The Economy Keep Up?.
The 10-year Treasury yield reached 5.25% Tuesday, its highest level in nearly two decades. The 30-year yield ended Tuesday at 5.57%, its highest level since 2002.
One possible explanation is actually a positive one: the economy is stronger than expected.
Picerno's median estimate from several third-quarter GDP nowcasts has climbed to a 3.2% annualized growth rate. Some estimates are considerably higher—the Atlanta Fed's GDPNow model was projecting 5% growth as of September 25.
But strong growth may not tell the entire story.
Picerno points to persistent inflation concerns, elevated energy prices and the government's large fiscal deficits as other possible reasons investors are demanding higher yields to hold long-term U.S. debt.
That's where the good-news story gets complicated. Higher yields may initially reflect a strong economy, but increasingly expensive borrowing can eventually become the thing that slows it down.
Wednesday's softer inflation numbers weren't enough to make that problem disappear.
Gold Gets No Help From PCE
Gold investors found that out firsthand.
In Gold Can't Catch A PCE Break As Long US Yields Keep Climbing, TalkMarkets contributor Christian Borjon Valencia notes that gold fell despite the better-than-expected inflation numbers and reduced expectations for another Fed hike.
At the time of his report, the 10-year Treasury yield had climbed to 5.302%, while the 30-year yield had reached 5.647%.
That's tough competition for an asset that pays no interest.
Gold was trading around $4,155 at the time, down roughly 0.6%, as rising Treasury yields overwhelmed what ordinarily might have been favorable news from the Fed's preferred inflation indicator.
Is Inflation Really an All-Clear for Stocks?
Wajeeh Khan of Invezz isn't convinced.
In Why PCE Inflation Data Is Not An All Clear For US Stocks, Khan points to some of the same economic strength that Picerno identifies.
Private employers added 90,000 jobs in September, beating expectations, while the Chicago PMI jumped to 58.8, indicating strong manufacturing activity.
That's good news if you're worried about recession.
It isn't necessarily good news if you're waiting for the Fed to declare victory and start loosening monetary policy.
One cooler inflation report doesn't erase a resilient labor market, stronger manufacturing activity and accelerating economic growth. Friday's official employment report could therefore be considerably more important for the interest-rate outlook than Wednesday's initial celebration suggested.
Nasdaq Bulls Aren't Giving Up
While the broader market struggled Wednesday, technology stocks held up considerably better.
Gianni Di Poce of TheoTrade remains firmly optimistic in Where The Nasdaq Goes From Here.
He sees the Nasdaq potentially reaching 32,000 or even 33,000 and views its recent consolidation near record highs as bullish rather than a sign that the rally is exhausted.
There was also an interesting rotation underway Wednesday. Money moved away from semiconductors and back toward software, with Microsoft (MSFT) reaching new highs and Palantir (PLTR), Nvidia (NVDA) and Alphabet (GOOGL) also showing strength.
Di Poce isn't ignoring the market's vulnerabilities. He notes that a relatively small number of stocks continue to carry much of the market higher, while the bond market and crude oil remain important variables.
Still, his view is that a market consolidating close to its highs is behaving more like a market preparing for another move upward than one preparing to collapse.
And AI Is Already Moving On to Its Next Act
One of Wednesday's more interesting TalkMarkets stories had little to do with PCE or Treasury yields but potentially plenty to do with where technology investing goes next.
In Why Muse Is Winning The Agentic AI Race, Andrew Rocco of Zacks Investment Research argues that artificial intelligence is entering a new phase.
The first wave was generative AI: ask a system a question and it produces an answer, image, program or document.
The next wave is agentic AI—systems capable of planning and actually carrying out multi-step tasks for users.
Rocco focuses on Meta (META)'s newly launched Muse and the emerging competition among Meta, OpenAI and Anthropic. His thesis is that Meta has several formidable advantages, particularly its enormous existing user base and ability to offer Muse for free.
Whether Meta ultimately wins that battle remains to be seen. But if Rocco is right about the larger transition, the next chapter of the AI boom may be less about which model can give the smartest answer and more about which one can actually get the most work done.
Heading Into the Fourth Quarter
And with that, the third quarter is in the books.
Wednesday gave investors a little bit of almost everything: encouraging inflation data, surprisingly resilient economic activity, soaring long-term yields, a struggling Dow, a stronger Nasdaq, falling gold and another reminder that the AI story continues to evolve at breakneck speed.
The inflation numbers give the Federal Reserve more room to wait.
The bond market, however, appears considerably less relaxed.
That makes Friday's employment report particularly important. If the labor market remains as resilient as some of this week's other economic data suggest, the debate over whether the Fed is really finished tightening may have a few chapters left to go.
Comments
Log in or sign up to join the conversation.