Stocks, dollar gain on allure of Fed soft landing

© Reuters. FILE PHOTO: A man looks at electric monitors displaying Japan's 10-year government bond yield on gilts and the exchange rate between the Japanese yen against the U.S. dollar outside a brokerage in Tokyo, Japan January 18, 2023. REUTERS/Issei Kato

By Herbert Lash

NEW YORK (Reuters) -World stocks rallied and the dollar edged up from eight-month lows on Friday as slowing inflation data raised hopes the Federal Reserve can engineer an economic soft landing and reduce its pace of aggressive monetary tightening next week.

U.S. consumer spending fell for a second straight month in December, a Commerce Department report said, which also showed the smallest gain in personal income in eight months that partly reflected moderate wage growth - booth good signs for inflation.

MSCI's gauge of stock performance in 47 countries gained 0.31%, after the index earlier hit fresh five-month highs, while the dollar index rose 0.187%.

"Equities have concluded the Fed really knows what they're doing, that they've shepherded the economy pretty well so far and really have a shot at a soft landing," said Dec Mullarkey, managing director of investment strategy and asset allocation at SLC Management in Boston.

"But what they have paid less attention to is growth and the growth picture is going to be scary this year. It's going to be low for good reason," Mullarkey said, referring to the Fed's pushing rates to "restrictive" levels to curb inflation.

A 5.0% annualized increase in the personal consumption expenditures (PCE) price index, the smallest gain since September 2021 in the Fed's preferred measure of inflation, indicated progress, said Russell Price, senior economist at Ameriprise Financial (NYSE:AMP), Troy, Michigan.

"Today's reading shouldn't alter the views of Fed officials, just so long as they were expecting further progress. But success is still far down the line," Price said, referring to the Fed's battle to lower inflation to its 2% target.

Futures showed the market pricing in a slightly higher peak of the Fed's overnight lending rate at 4.912% in June. The market then sees rates easing to 4.473% in December on expectations the Fed cuts rates later this year.

The Fed, however, will be in no rush to cut rates, contrary to what the market perceives, Mullarkey said.

"The simple, obvious reason is that cutting rates too soon can ignite another round of inflation and that would absolutely shred their credibility," he said.

The yield curve on three-month Treasury bills and 10-year notes, in the past a solid predicator of a looming recession when yields on the short end are higher, or inverted, than the long end, was at -116.1.

Wall Street see-sawed a bit in early trade before moving ahead. The Dow Jones Industrial Average rose 0.08%, the S&P 500 advanced 0.25% and the Nasdaq Composite added 0.95% too post its fourth straight weekly gain.

In Europe, the broad STOXX 600 index closed up 0.26% as all major bourses in Europe closed higher.

Investors tussled with mixed earnings from the region, but easing U.S. inflation bolstered sentiment ahead of major central bank decisions next week.

"The earnings angle is a mixed bag. Some corporates appear to show earnings holding up, while others are reporting disappointing numbers," said Stuart Cole, head macro economist at Equiti Capital in London.

Besides the Fed, investors await central bank meetings by the European Central Bank and Bank of England and how officials respond to data showing major economies are holding up rather well as they continue to raise interest rates.

Sterling slipped 0.10% to $1.2393 on investor unease that a British slowdown may prompt the BoE to end its tightening cycle soon, a move that could weaken the pound in the short-term.

The euro slid 0.22% to $1.0865, just off from a nine-month high of $1.09295 it touched on Monday.

Treasury yields rose after Japanese inflation data surprised on the upside. Core consumer prices in Tokyo, a leading indicator of nationwide trends in Japan, increased 4.3% in January from a year earlier, marking the fastest annual gain in nearly 42 years.

The yield on 10-year Treasury notes rose 2.5 basis points to 3.516%.

Asia-Pacific shares maintained their best start to a year overnight with a nine-month high despite ongoing drama in India, where shares of Adani Enterprises sank another 20% in the wake of Hindenburg Research's report about the firm's debt levels and use of tax havens.

Oil prices reversed earlier gains as indications of strong Russian oil supply offset better-than-expected U.S. economic growth data, strong middle distillate refining margins and hopes of a rapid recovery in Chinese demand.

U.S. crude futures slipped $1.33 to settle at $79.68 a barrel, while Brent settled down 81 cents at $86.66.

Gold prices steadied, with gains capped by the stronger dollar.

Spot gold % to $1,928.37 an ounce.