Inflation is cooling, and Wall Street loves it

By Paul R. La Monica, CNN Business

(CNN) - Stocks ended the day higher Tuesday after the US government reported that wholesale prices rose at a far less dramatic rate than expected. That news come just a few days after another report showed that the pace of consumer price increases was also slowing.

The Dow rallied nearly 60 points, or 0.2%, after giving up much of its gains from earlier in the day. The S&P 500 and Nasdaq rose 0.9% and 1.5%.

Stocks pulled back a bit following reports that two missiles or rockets struck a village in Poland near the border with Ukraine. Two people had reportedly died.

Still, investors largely looked past the geopolitical headlines and are hoping that the cooling inflation pressures will lead the Federal Reserve to raise interest rates by smaller amounts in the next few months, following four consecutive historically large hikes.

Solid earnings from retail giant Walmart, one of the 30 components in the Dow, also helped boost market sentiment. Walmart stock rose more than 6.5%.

Tech stocks got a lift from the surprise news that Warren Buffett's Berkshire Hathaway bought a stake in chip giant Taiwan Semiconductor during the third quarter.

Shares of Taiwan Semi skyrocketed more than 10%. The benchmark Philadelphia Semiconductor Index, which has Taiwan Semi, Intel, AMD, Nvidia and other chip leaders in it, gained 3%.

But it's the good news on the inflation front that is giving investors the biggest cause for jubilation. Traders are now betting that it's almost a slam dunk that the Federal Reserve will raise rates by only a half-percentage point, instead of three-quarters of a point, at its next meeting on December 14.

Traders are pricing in a more than 80% chance of only a so-called 50 basis point increase at that meeting, compared to a less than 30% probability a month ago, according to federal funds futures on the CME.

In addition to the more benign inflation numbers, investors also seem to be taking solace from comments made by Fed vice chair Lael Brainard on Monday.

Brainard said at a Bloomberg News event "it makes sense to move through a more deliberate and data-dependent pace" when it comes to future rate hikes. Those comments soothed investors, who were spooked by remarks from another Fed official about inflation and interest rates.

Fed governor Christopher Waller told attendees of a UBS event in Australia that "we've got a long, long way to go to get inflation down," and added that "rates are going to keep going up, and they are going to stay high for a while."

Investors may be overestimating chance of a Fed pivot

Still, some experts worry that the market is getting too excited about the latest inflation figures. The Fed is clearly still more concerned about inflation than it is the possibility its aggressive rate hikes will slow the economy.

"It's less clear if [the inflation reports] will be sufficient for the Fed to reconsider how far they go in hiking rates," said Andrzej Skiba, head of US fixed income at RBC Global Asset Management. "The Fed will need more data. It really is all about inflation, and everybody is going to be glued to their screens for new data."

Others agree that the Fed is unlikely to suddenly decide that it will be able to declare victory in the war against inflation anytime soon. That means the market should get used to the notion that interest rates are going to keep climbing and may stay elevated for some time.

"Getting inflation down is going to be much more of a focus than it was during the past fifteen years," said Ashish Shah, chief investing officer of public investments for Goldman Sachs, during a webcast Monday.

Shah said investors should not expect a "Goldilocks" type scenario where the Fed comes to the rescue of the markets with rate cuts and big bond purchases (a policy known as quantitative easing) in order to push interest rates lower.

David Page, head of macro research at AXA IM, agreed with that assessment. He said the growing expectations that the Fed could begin to lower rates as soon as the end of next year are overly "optimistic."

Page said he believes the Fed may raise rates, currently in a range of 3.75% to 4%, two more times to 4.75% to 5% by March before pausing. He added that the Fed may then be on hold until 2024 and is unlikely to start reducing rates unless the job market weakens significantly.

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