Investors Are Walking a Tightrope as Stocks Rise for a Second Week

Wall Street notched a second week of gains on Friday, a cautious rally that’s come as investors anticipate an easing in the Federal Reserve’s inflation fight, but have to balance that against the prospect that interest rates could remain high for some time.

The S&P 500 rallied back from earlier losses to finish up 0.4 percent for the day, taking the index to a gain of 2.7 percent for the week and 4.2 percent since the start of the year.

After waving goodbye to the worst performance for the S&P 500 since 2008 last year, investors have begun the new year walking a tightrope. Signs of cooling inflation pressure have raised expectations that the Fed may not raise interest rates much further — after they rose from near zero to a target range of 4.25 to 4.5 percent in just nine months. But borrowing costs will nonetheless remain elevated, slowing the economy and cutting further into corporate profits. Higher interest rates increase costs for consumers and companies, weighing on the stock market.

Investors have embraced the potential for a shift in the Fed’s fight against inflation, with a slowdown in the pace of consumer price inflation this week bolstering expectations that the central bank could raise interest rates by just 0.25 percentage points next month, smaller than the 0.5 percentage point rate increase that it raised in December.

Some analysts expect that increase to be the last such move for now, and investors in the futures markets are betting that a downturn in the economy could cause the Fed to begin lowering interest rates later this year.

Both of those views stand in contrast to what the central bank has said it plans to do.

“Even though the Fed is saying they will not cut interest rates, the market is saying that in three to six months we will have recession, we will have moderating inflation and you will be singing a different tune,” said Andrzej Skiba, head of U.S. fixed income at BlueBay Asset Management. “There is a massive difference between what we are hearing from the Fed, and what the market is thinking will occur.”

Friday marked the unofficial start of “earnings season,” where Wall Street analysts face-off against America’s largest companies over their profits for the end of 2022 and their expectations for the year ahead. Early reports from a number of big financial institutions showed stable profits but rising concerns about the economy. JPMorgan, the largest bank in the United States, reported higher profits than analysts had expected but warned that the economy was headed toward a “mild recession” later in the year. The bank’s stock price initially fell in early morning trading, before rebounding to a rise of 2.5 percent for the day.

Just how mild the recession might be depends on how long inflation stays above the Fed’s target of 2 percent and therefore how long the central bank feels it needs to keep interest rates high.

Despite the latest reading showing an overall slowdown in inflation, the Consumer Price Index data also pointed to continued price pressure in areas of the economy reliant on consumer demand.

That’s worrying for the Fed as it points to the strength of the labor market and wage gains that are impeding the central bank’s job of lowering inflation more quickly.

Delta Air Lines on Friday surpassed analysts expectations for earnings in the fourth quarter of 2022 but warned that rising labor costs would knock its performance early this year. The company’s share price fell 3.5 percent on Friday.

“The last couple of days have shown the tug of war now characterizing market sentiment,” said David Donabedian, chief investment officer of CIBC Private Wealth US.