Traders Sniffing Out a Soft Landing

The stock market rallied this morning, building on Friday’s gains. Currently, the Dow is up 130 points and the S&P 500 is up 1%. Investors are expressing some hope that the Fed can begin to relax its aggressive approach to fighting inflation. Bonds are rallying as well, pushing yields lower in tandem with interest rate expectations.

Last week we got evidence that the services side of the economy is weakening. ISM’s Non-Manufacturing Index slid below 50, the dividing line between expanding and contracting business activity. Sharp deterioration over the past month surprised economists. Most industries cited slowing demand, especially real estate and wholesale trade. If there was any good news, it was that inflation (“prices paid”) plunged to the lowest level in two years. Companies are clearly in cost control mode, and this will help.

Friday’s jobs report spurred a broad stock market rally. The economy generated 223,000 new jobs compared with about 203,000 expected. The unemployment fell back to 3.5%, the lowest level in more than 50 years. At the same time, wage growth slowed. Average hourly earnings decelerated to 4.5%, from 5.5% a year ago. This combination of numbers implies that the Federal Reserve may be able to have its cake and eat it too. That is, falling wage inflation alongside a resilient labor market may help us avoid recession.

It appears the Fed is beginning to win its war on inflation. We’ll know more on Thursday when December’s Consumer Price Index (CPI) report is released.