U.S. Stocks Surge Wednesday on CPI Data and Strong Bank Earnings

TradingKey - The U.S. stock market rebounded from early January's gloom as core consumer price inflation came in better than expected and some of the largest banks kicked off earnings season on a positive note.

The CPI report released on Wednesday tempered investor concerns about persistent inflation. Core CPI, which excludes food and energy, rose 3.2% year-over-year, slightly lower than the 3.3% forecast and down from the previous month. Following the news, the S&P 500 surged nearly 2% by Tuesday’s close, while Treasury yields declined.

Wall Street regained confidence that the Federal Reserve may cut rates further later this year. According to data from the CME Group, futures pricing indicates that the Fed is almost certain to hold rates steady at its January 28-29 meeting. However, assuming quarter-point rate cuts, markets are pricing in nearly a 50% chance of two rate cuts by the end of the year. The next rate cut is expected to occur in May or June.

“Today’s CPI may help the Fed feel a little more dovish. It won’t change expectations for a pause later this month, but it should curb some of the talk about the Fed potentially raising rates,” said Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management. “And judging by the market’s initial response, investors appeared to feel a sense of relief after a few months of stickier inflation readings.”

Strong bank earnings reports also fueled investor optimism. Citigroup, Goldman Sachs, JPMorgan Chase, and Wells Fargo, along with the S&P 500 and Nasdaq Composite, posted their largest single-day gains since November 6, the trading day after the presidential election.

Wall Street banks saw strong profit growth at the end of last year, driven by a surge in trading activity. Following the U.S. presidential election on November 5, banks benefited from a significant increase in equity trading volumes, which contributed to their robust performance. Donald Trump’s victory sparked a stock market rally, drawing investors into equities.

Source: FT

The steepening U.S. Treasury yield curve is also expected to support bank profits. A steeper yield curve allows banks to borrow at lower short-term rates and lend at higher long-term rates, boosting net interest income. According to Dealogic data, investment banking fees rose 26% year-over-year in Q4, driven by increased transaction volumes and strong demand for bond underwriting.

Goldman Sachs analyst Ramsden predicts that net interest income (NII) will grow by mid-single-digit percentages across the banking sector in 2025, while total fees are expected to increase by mid-to-high single digits.

The biggest challenge for the stock market is whether this bullish sentiment can sustain, given the uncertainty around the Trump administration’s tariff and tax policies and their potential impact on the already significant U.S. debt.

“Going into today, we thought the market was overly bearish,” said John Luke Tyner, head of fixed income at Aptus Capital Advisors. “I am not surprised to see this response.” Tyner added, “I’m pretty nervous about the long end” of the Treasury curve.

Despite the Federal Reserve’s rate cuts since September, Treasury yields have climbed sharply amid a recovering U.S. economy and a strong labor market. Furthermore , investors worry that Trump’s policies could sustain high inflation, with rising yields posing risks to growth stocks, especially given elevated valuations.

Trump’s proposed tax cuts, if implemented without corresponding spending reductions, could increase fiscal spending and the debt burden, potentially triggering further bond sell-offs.  

“I think tax policy is probably the biggest unknown right now for markets,” said Richard Steinberg, chief market strategist at Focus Partners Wealth. “What happens with fiscal and tax policy, and how does the 10-year yield respond to it? That’s going to be key.”