Stocks, Treasuries rally on hopes Fed will slow inflation

NEW YORK - Investors suffering through a rough year are hoping that recent signs of wobbling economic growth will force the Federal Reserve and other central banks to take their foot off the gas in the fight against inflation, sparking sharp rebounds in stocks and bonds.

The S&P 500 has gained 5% over the last two days after a brutal September in which it fell 9.3% alongside declines in other global equity benchmarks. The yields on U.S. Treasuries, which move inversely to prices, have plummeted by nearly 35 basis points in October from multi-year highs hit last month.

The move comes as investors anticipate that the Fed will raise rates in its effort to crush inflation because of recent signs that growth in the U.S. may be slowing down. The fed fund rate is expected to reach 4.5% next year, according to investors in the futures markets, compared to the expected peak of 4.7% they were pricing in last week.

Jim Paulsen, chief investment strategist at the Leuthold Group, said the markets are sniffing out a blink by the Fed. If they pause here, not only does the rate pressure drop, but it also means that you end up with a mid-cycle slowdown rather than a recession. Markets have rallied on the hopes of a Fed pivot several times this year, only to reverse and crumble to new lows, making investors wary of the current bounce. A series of weaker than expected data on manufacturing and job openings in the United States is fueling hopes that weaker growth will push the Fed to slow its market-punishing rate hikes.

Some investors have taken Tuesday s smaller-than expected rate increase from Australia's central bank and a decision by the UK s new government to scrap planned tax cuts as signs that governments and monetary authorities are responding to signs of weakening growth and market instability.

Some people are skeptical of the moves. Mark Haefele, chief investment officer at UBS Global Wealth Management, said the stock rebound was due to oversold conditions in the S&P 500, which was exacerbated by the month-end rebalancing by money managers at the end of September that drove stocks lower.

With sentiment toward equity already very weak, periodic rebounds are to be expected. He wrote in a Tuesday report that markets are likely to stay volatile in the near term due to expectations around inflation and policy rates.

Retail traders have shown little signs of capitulation, a signal that they say would represent a potential market bottom, according to analysts at BofA Global Research on Tuesday. The Wall Street fear gauge, known as the Cboe Volatility Index, has not climbed to levels that have marked past turning points in past sell-offs.

It is not clear that you have seen panic yet, said Ashwin Alankar, head of Global Asset Allocation at Janus Henderson Investors. If you see panic, it is not the best time to add risk to a portfolio at a rapid clip. The labor market's labor market is showing signs of a softening in the labor market, as shown by JOLTS data, may not be enough for the Fed to feel comfortable pausing in its rate hikes, analysts at Capital Economics wrote on Tuesday.

The data won't prevent further aggressive interest rate hikes in the near term, but it supports our view that inflation will drop back faster than Fed officials expect, they wrote.