Stock Market Rebounds, But Smaller U.S. Rate Cut Expected

September is living up to its reputation as being one of the worst months for the stock market. After a volatile start to August, which saw the S&P 500 and TSX both tumble more than 5%, North American stocks experienced another big drop in early September after U.S. core inflationary data came in higher than expected. This all but puts an end to a much hoped-for oversized interest rate cut from the Federal Reserve.

In early August, North American stocks took a big hit following a run of weak economic data. It took two weeks for Canadian stocks to erase those losses and almost a month for U.S. stocks to recover.

That momentum was upended in early September after the U.S. Bureau of Labor Statistics announced that the overall consumer price index (CPI) came in lower than expected in August; prices cooled for the fifth straight month to 2.5%, slightly below analyst forecasts of 2.6%.

Investors were spooked though after the core reading on the CPI, which strips out volatile energy and food categories, came in slightly higher than expected. On a month-over-month basis, core CPI increased 0.3% versus the 0.2% increase Wall Street was looking for.

After the raft of weak economic data came out in early August, investors were expecting the U.S. Federal Reserve to announce a big 50-basis-point cut when it meets again on September 18.

But the stronger-than-expected core CPI reading has all but dashed hopes for a big interest rate cut. Instead, the market is now pricing in an 85% chance that the Federal Reserve will approve a 25-basis-point (0.25%) interest rate cut. This would take the target rate down to a range of 5.0% to 5.25%.

The news led U.S. stocks significantly lower following the CPI announcement on September 11, but investor pessimism didn’t last long. On its own, the hotter-than-expected core CPI data wasn’t really all that bad.

After the dust settled, investors realized that inflation was cooling, the U.S. was not in a recession and economic data showed no signs of a pending recession. In fact, it continues to look like the U.S. will achieve a soft economic landing.

By Thursday, September 12, the Dow Jones Industrial Average and S&P 500 both registered their biggest comeback in two years. The TSX meanwhile hit a new record high that day of 23,482.33.

While every economic cycle is different, for the most part, the lowering of interest rates will make it cheaper for businesses and consumers to borrow, which tends to be good news for Canadian and U.S. stocks.

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