SShares soared Wednesday morning after better-than-expected inflation data promised relief for consumers struggling to keep up with soaring prices.
The consumer price index (CPI), a measure of price changes for a variety of goods and services, rose 8.5% in July from a year earlier, according to data from the Labor Department. It’s a slowdown since June, when consumer prices rose 9.1% year-on-year — the biggest rise in four decades.
Investors seemed to like the latest inflation numbers. The S&P 500 was up as much as 1.9% after the data was released Wednesday morning, while the Dow Jones Industrial Average was up about 1.6% and the Nasdaq Composite was up more than 2%.
The lower-than-expected CPI data is likely welcome news for the Federal Reserve, which has been raising interest rates to combat high prices. But what exactly does this mean for investors?
How inflation is affecting stocks (and the Fed).
Investors aren’t necessarily reacting to the inflation data itself, but to how the Federal Reserve is likely to react to the new report.
The central bank often raises short-term interest rates when inflation is high to cool economic activity. The goal is to bring prices down without cooling activity so much that the economy slides into recession. Higher interest rates limit the ability of businesses and consumers to borrow and spend money, which can lower the price of goods and services, but also lower the prices of financial assets such as stocks.
Investors appear to be hoping that the latest data will support the notion that inflation has peaked and that the Fed will therefore be able to slow rate hikes.
What’s next for inflation and the stock market?
Even ahead of Wednesday’s data, the stock market was recovering from a dismal first half of the year. Jim Paulsen, chief investment strategist at The Leuthold Group, told Money earlier this week that he believes the main reason for the rally is that investors believe in the idea that the “economic tightening cycle” is nearing a pause.
Not everyone is so optimistic. Scott Wren, chief global market strategist at the Wells Fargo Investment Institute, wrote in a report on Wednesday that he disagreed with the idea that the Fed would “turn” this year and pause or scale back rate hikes.
“A sudden reversal in headline inflation readings could send equity markets prematurely higher as investors believe the trend has finally turned down,” Wren wrote. “We don’t think inflation will fall as fast as it has risen.”
Kathy Jones, Charles Schwab’s Chief Fixed Income Strategist, tweeted Wednesday that the CPI data, while “definitely good news,” was only “one in a row.”
“The Fed needs to see a set of numbers showing inflation declining before it turns around,” Jones wrote.
Plenty of data is expected before the next Federal Open Market Committee in September – when the Fed is expected to make a decision on the next possible rate hikes, she added. It’s also important to remember that inflation, while falling, is still close to a 40-year high.
Overall, financial advisors tend to advise long-term investors not to react to news with knee-jerk adjustments to their investment portfolios. A well-diversified portfolio and a strong investment plan tailored to your goals, time horizon, and risk tolerance is probably your best bet when it comes to building wealth through the stock market — whatever the Fed’s next move.
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