S&P 500, Nasdaq close at highest in 15 months after inflation data takes some pressure off Fed

By Isabel Wang and Frances Yue

U.S. stocks rose on Wednesday with the S&P 500 and Nasdaq Composite closing at their highest levels in 15 months, after data showed the rate of inflation in June slowed to the lowest level since early 2021, fueling hopes that the Federal Reserve may be close to being done with its interest-rate hikes, while the Fed's Beige Book said the U.S. economic activity increased slightly since late May.

How stocks traded

On Tuesday, the Dow Jones Industrial Average rose 317 points, or 0.93%, to 34,261; the S&P 500 increased 30 points, or 0.67%, to 4,439; and the Nasdaq Composite gained 75 points, or 0.55%, to 13,761.

What drove markets

Stocks finished higher while Treasury yields and the U.S. dollar fell after the consumer price index data on Wednesday showed U.S. inflation at its lowest pace in more than two years.

See: U.S. dollar falls to over one-year low after CPI data shows inflation slowing again in June

U.S. consumer prices rose a modest 0.2% in June. Economists polled by the Wall Street Journal forecasted an increase of 0.3%. The yearly rate of inflation decelerated to 3% from 4% in the prior month, marking the lowest level since March 2021.

The so-called core rate of inflation that omits food and energy rose a mild 0.2% last month for the smallest increase in almost two years. Wall Street had forecast a 0.3% gain. The annual rate of core inflation decreased to 5% from 5.3% in the prior month.

See: U.S. inflation slows again, CPI shows, as Fed weighs another rate hike

The markets have been receiving the CPI print "pretty well," said Brian Katz, chief investment officer at the Colony Group.

The lower-than-expected CPI data is likely to "prolong the uptrend [in stocks] that we've been experiencing this year," Katz in a call. "As long as we are in this environment where disinflation continues and we have reasonable growth, it is a good environment for risk assets," Katz said.

Inflation in June fell in a majority of the important categories, most notably housing prices, which had been elevated, according to George Mateyo, chief investment officer at Key Private Bank.

"The Fed will embrace this report as validation that their policies are having the desired effect -- inflation has fallen while growth has not yet stalled. But it most likely won't change their mind to raise interest rates later this month," Mateyo wrote in emailed comment Wednesday.

See: See how much inflation has raised your cost of living, using MarketWatch's guide

"Today is those weird days where good news was actually good news for almost everybody," said Phillip Toews, chief investment officer of Toews Asset Management.

However, Toews said one thing that people aren't necessarily considering is the "potential circuitous pathway" that inflation can follow. Good CPI readings will potentially allow interest rates to stabilize later this year, making the housing and labor market stronger, but that will again have impact on inflation, said Toews.

"Watch out for waves; watch out for multiple spikes," Toews told MarketWatch in a phone interview on Wednesday. "The risk may be more of a demand-pull situation, which is that you have a lot of strong labor and lot of wealth, and that could be one of the primary things that drives inflation back up again. That's a real risk here that we're now full risk-on again, and there's a possibility that it could change in the next three or six months -- we see inflation re-emerge."

Fed-fund futures traders priced in a 92.4% chance that the Fed will raise its benchmark interest rate by 25 basis points in its meeting later this month, according to CME Fed Watch. They priced in a 12.9% likelihood that the U.S. central bank will raise interest rates again in September but that is down from 22.3% a day ago.

See:Fed's Beige Book points to continued slow economic growth

Economic activity in the U.S. rose slightly in late May and June, according to the central bank's latest Beige Book report released Wednesday.

The Fed's business contacts across the nation said that economic activity increased only slightly in the past two months, and the slow growth was expected to continue. The central bank said that five of its 12 districts reported slight or modest growth, five noted flat activity and two reported slight or modest declines.

See: Megabank profits on tap after eventful Q2 of bank failures and climbing interest rates

Investors also looked ahead to the start of second-quarter earnings season, with the nation's biggest banks such as JPMorgan Chase & Co. (JPM) , Wells Fargo & Co. (WFC) and Citigroup Inc. (C) due to release their results on Friday.

Bank of America Corp. (BAC) and Morgan Stanley (MS) will provide their second-quarter updates on July 18, followed by Goldman Sachs Group Inc. (GS) on July 19.

Meanwhile, U.S. government bank regulators should run a new "high-inflation" stress test to identify at-risk banks and be able to better gauge their capital shortfalls, said Minneapolis Federal Reserve President Neel Kashkari on Wednesday.

"The potential losses banks face today from interest rate risk appear to be more idiosyncratic than systemwide, and this high-inflation stress test would help banks prepare for a worse-than-expected scenario," Kashkari said, in a blog post and a subsequent panel discussion on bank stability hosted by his regional Fed bank.

Companies in focus

-- Jamie Chisholm contributed.

-Isabel Wang

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07-12-23 1626ET

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