Wall Street traders betting that further inflation softening could bolster the case for a Federal Reserve downshift drove a rally in both stocks and bonds.

Investors looked beyond the drumbeat of hawkish Fedspeak, a potentially miserable stretch of earnings and the specter of a recession to focus on the upcoming consumer price index. It should probably come as no big surprise that tech, one of the most-beaten down groups during the Fed’s tightening campaign, led gains Wednesday. That advance also reflected the drop in U.S. yields.

Suffice to say that Thursday’s CPI will be scrutinized top to bottom, with the big focus on the core inflation — which excludes food and energy and is seen as a better indicator than the headline measure. While a projected 5.7 per cent  increase is well above the Fed’s goal, helping explain its intention of keeping rates higher for longer, the year-over-year price growth would also show moderation.

A survey conducted by 22V Research showed that 67 per cent  of respondents expect core CPI to come in lower than consensus — with 63 per cent  betting the report will be “risk-on” for markets.

“An in-line or softer-than-expected CPI will likely result in a rally, whereas a hotter number could easily tip over the applecart,” said Arthur Hogan, chief market strategist at B. Riley Wealth. “Good news for the economy can become good news for markets.”

Now the caveat is that if the headline number drops, but core CPI doesn’t, the report won’t be that positive, wrote Tom Essaye, a former Merrill Lynch trader who founded The Sevens Report newsletter. Another aspect is that Wall Street’s focus on the change in prices rather than the level of inflation could be problematic as far as monetary policy goes, according to Torsten Slok of Apollo Global Management.

The market would conclude that “inflation is coming down, so everything is fine and we can trade stocks higher and credit spreads tighter,” Slok added. “But this is a problem for the Fed because the Fed is worried that easier financial conditions will delay further the move in inflation back to 2 per cent .”

‘SELL THE NEWS’

To Brian Overby, senior markets strategist at Ally, one thing to keep in mind is that stocks have already climbed off the lows, so the market is not as coiled for as bullish of a bounce as we got after recent data.

“The concern is that a move higher could be a ‘sell the news’ event as earnings come into focus Friday,” he noted.

As traders get ready for the start of the bank earnings season there’s a sense they will be less interested in seeing how robust profits were and more focused on signs the industry is girding for a major downturn as rate increases crimp economic activity.

Fed Bank of Boston President Susan Collins said she’s leaning toward supporting a quarter-point hike at the central bank’s next meeting ending Feb. 1. Downshifting to a smaller move would give officials more time to see how their actions are affecting the economy, she told The New York Times.

Closely followed strategist Edward Yardeni, who saw resilience in the U.S. economy even as recession worries grew last year, remains sanguine on where global financial assets — including U.S. stocks — are headed. 

“The outlook for the world economy is actually improving,” the founder of Yardeni Research Inc. told Bloomberg Television. U.S. equities “made a low on Oct. 12. That was the end of the bear market and we’re back in a bull market.” Since then, the S&P 500 has risen more than 10 per cent .

Meantime, Pacific Investment Management Co., says that while a recession could further challenge riskier assets like stocks, “we continue to see a strong case for investing in bonds, after yields reset higher in 2022 and with an economic downturn looking likely in 2023.”

“There is uncertainty as to whether we’re going to see a recession or a soft landing,” said Maria Vassalou, co-chief investment officer of multi-asset solutions at Goldman Sachs Asset Management. “We remain cautiously positioned in risky assets and we’re somewhat underweight equities. But we think that the macro landscape will be clearer in the coming months and quarters, and that would also present a lot of investment opportunities.”

Key events this week:

• U.S. CPI, initial jobless claims, Thursday
• St Louis Fed President James Bullard at Wisconsin Bankers Association virtual event, Thursday
• Richmond Fed President Thomas Barkin speaks at VBA/VA Chamber, Thursday
• China trade, Friday
• U.S. University of Michigan consumer sentiment, Friday
• Citigroup, JPMorgan, Wells Fargo report earnings, Friday

Some of the main moves in markets:

Stocks

• The S&P 500 rose 1.3 per cent  as of 4 p.m. New York time
• The Nasdaq 100 rose 1.8 per cent
• The Dow Jones Industrial Average rose 0.8 per cent
• The MSCI World index rose 1 per cent

Currencies

• The Bloomberg Dollar Spot Index was little changed
• The euro rose 0.2 per cent  to US$1.0753
• The British pound was little changed at US$1.2145
• The Japanese yen fell 0.2 per cent  to 132.55 per dollar

Cryptocurrencies

• Bitcoin rose 0.5 per cent  to US$17,557.38
• Ether rose 0.3 per cent  to US$1,342.63

Bonds

• The yield on 10-year Treasuries declined nine basis points to 3.53 per cent
• Germany’s 10-year yield declined 10 basis points to 2.20 per cent
• Britain’s 10-year yield declined 15 basis points to 3.41 per cent

Commodities

• West Texas Intermediate crude rose 3.3 per cent  to US$77.59 a barrel
• Gold futures rose 0.2 per cent  to US$1,880.80 an ounce