S&P 500 Rallies 2.67%, Tech Giants Lead Amid Stagflation Fears

Key Takeaway

• US markets rally despite slow disinflation, dismissing stagflation fears with a 2.67% S&P 500 increase, signaling strong economic growth.
• The "Magnificent Seven" tech giants drive S&P 500 profit growth, with earnings significantly outperforming the rest of the market.
• Japanese yen hits new lows against the dollar, raising questions about potential BOJ intervention amidst sticky US inflation and rate cut expectations.

Inflation Challenges and Market Optimism

The US economy is navigating through a phase of slow disinflation, avoiding the feared stagflation scenario. Despite a surge in bond yields triggered by persistent inflation concerns, the stock market experienced a significant rally, with the S&P 500 climbing 2.67% in its best performance since November. This paradoxical situation arises from the market's interpretation of inflation as a sign of economic vitality rather than stagnation. The latest GDP data revealed a slight dip in growth but confirmed the economy's resilience, while inflation rates, particularly in core services excluding housing, continue to rise, albeit at a slower pace. The Federal Reserve's preferred inflation measure, the personal consumption expenditures (PCE) index, showed a modest increase, reinforcing the notion that while disinflation is underway, it remains a gradual process.

The Fed's Stance and Financial Conditions

Market reactions to the inflation data were surprisingly positive, buoyed by the belief in the "Fed Put" — the expectation that the Federal Reserve will not tighten monetary policy more than necessary and will intervene if economic conditions worsen. This confidence has kept financial conditions relatively easy, with credit markets showing little concern over inflationary pressures. The resilience of credit spreads indicates a market that is not anticipating significant economic turmoil, contrasting sharply with the tightening financial conditions seen in previous periods of rate hike expectations.

The Magnificent Seven's Market Influence

A critical driver of the recent stock market rally is the performance of the "Magnificent Seven," a group of giant technology firms. These companies have significantly outperformed the broader market, with their earnings growth starkly contrasting with the rest of the S&P 500. This disparity highlights the market's deep reliance on these tech giants, raising questions about the sustainability of their earnings and the potential implications for other large companies. The dramatic price movements of these firms, including substantial gains and losses in response to earnings announcements, underscore their outsized influence on market dynamics.

Yen Weakness and Global Implications

The Japanese yen's continued depreciation, despite expectations of government intervention, reflects broader global economic trends. The Bank of Japan's decision to maintain low interest rates, coupled with sticky inflation in the US reducing rate cut expectations, has put downward pressure on the yen. This situation has broader implications for global financial markets and raises questions about the effectiveness of potential interventions in the face of dominant US monetary policy. The yen's weakness benefits Japan's tourism sector and exporters but poses challenges for policymakers balancing domestic and international economic considerations.