Dow Hits Record High as Inflation Cools, Paving Way for Fed to Focus on Labor Market

The blue-chip Dow rose on Friday to hit an intraday record, and small-cap stocks outperformed, as a benign inflation report cleared the way for the Federal Reserve to focus on shoring up the labor market while continuing its interest rate easing.

Cooling Inflation Fuels Optimism for Accelerated Fed Easing Cycle

Moderate Consumer Spending Suggests Solid Economic Momentum

A Commerce Department report showed that consumer spending increased moderately in August, suggesting the economy retained some of its solid momentum in the third quarter, while inflation pressures continued to abate. This data provided the Federal Reserve with the necessary room to commence its policy easing cycle with a 50-basis-point cut last week, and investors are now hopeful that the central bank may accelerate this cutting cycle.

Small-Cap Stocks Outperform as Investors Favor Low-Rate Environment

The Russell 2000 index, which tracks small-cap stocks that fare better in a low-rate environment, gained 1.5% to a one-week high, outperforming the broader market. This performance reflects investors' optimism that the Fed's continued interest rate easing will create a more favorable environment for smaller, more agile companies.

Sector Rotation Favors Energy and Financials, Tech Stocks Decline

Ten out of the 11 S&P 500 sectors were higher, led by a 2% rise in energy stocks, while technology stocks declined 1%. Nasdaq components such as Nvidia and Microsoft lost 2.7% and 0.5%, respectively, as investors turned their focus to other sectors, including financials and healthcare, which were the biggest boosts to the Dow.

Investors Anticipate Accelerated Fed Easing Cycle

Investors now slightly favor a bigger 50-basis-point cut at the Fed's next meeting, with a 52.1% chance, up from a coin toss before the data, as per the CME Group's FedWatch Tool. This shift in sentiment reflects the market's belief that the Fed may accelerate its interest rate easing cycle in response to the cooling inflation pressures.

Labor Market Reports to Take Center Stage Next Week

With the inflation data providing the Fed with the necessary room to focus on the labor market, investors' attention will now shift to a slew of labor market reports due next week. These reports will be closely watched for any signs of weakness or strength, as they will likely influence the central bank's future policy decisions.

Consumer Sentiment Improves, Boosting Market Optimism

The University of Michigan's final September estimate on consumer sentiment stood at 70.1, compared with estimates of 69.3, as per economists polled by Reuters. This improvement in consumer sentiment further bolsters the market's optimism, as it suggests that the economy may be weathering the current challenges more effectively than previously anticipated.

Chinese Stocks Surge on Central Bank's Easing Measures

U.S.-listed shares of Chinese firms such as Alibaba rose 2.8%, PDD Holdings climbed 4.4%, and NetEase gained 3% after China's central bank lowered interest rates and injected liquidity into the banking system. This optimism spilled over to miners such as Arcadium, which added 3.5%, and U.S.-listed shares of BHP, which rose 1.8%.