Stocks end higher as Fed sees progress against inflation

Traders work on the floor at the New York Stock Exchange in New York, Wednesday, Feb. 1, 2023. You may be sick of politics, but Wall Street is just getting to its favorite part of the presidential calendar. The third year of the presidential cycle has historically been the best for the stock market. (AP Photo/Seth Wenig

Traders on the floor at the New York Stock Exchange watch Federal Reserve Chair Jerome Powell's news conference after the Federal Reserve interest rate announcement in New York, Wednesday, Feb. 1, 2023. (AP Photo/Seth Wenig)

Traders work on the floor at the New York Stock Exchange in New York, Wednesday, Feb. 1, 2023. (AP Photo/Seth Wenig)

Traders on the floor at the New York Stock Exchange watch Federal Reserve Chair Jerome Powell's news conference after the Federal Reserve interest rate announcement in New York, Wednesday, Feb. 1, 2023. (AP Photo/Seth Wenig)

Traders on the floor at the New York Stock Exchange watch Federal Reserve Chair Jerome Powell's news conference after the Federal Reserve interest rate announcement in New York, Wednesday, Feb. 1, 2023. (AP Photo/Seth Wenig)

Traders on the floor at the New York Stock Exchange watch Federal Reserve Chair Jerome Powell's news conference after the Federal Reserve interest rate announcement in New York, Wednesday, Feb. 1, 2023. (AP Photo/Seth Wenig)

NEW YORK (AP) — Wall Street rose to its highest level since the summer following the latest hike to interest rates by the Federal Reserve, which said it’s finally seeing improvements in inflation. The S&P 500 rallied back from an early 1% loss Wednesday to rise 1%. The Nasdaq jumped 2% and the Dow ended barely higher. As expected, the Fed raised its benchmark rate by 0.25 percentage points to its highest level since late 2007. It’s the smallest increase in the Fed’s blizzard of rate hikes since March. The Fed’s chair said more increases are likely needed, but he also said the disinflationary process has started.

THIS IS A BREAKING NEWS UPDATE. AP’s earlier story follows below.

NEW YORK (AP) — Wall Street leaped to its highest level since the summer on Wednesday following the latest hike to interest rates by the Federal Reserve, which said it’s finally seeing improvements in inflation.

The S&P 500 rallied back from an early 1% loss to rise 1.5% after Fed Chair Jerome Powell said the economy is on the path toward getting inflation lower following a burst of rate hikes. The Dow Jones Industrial Average also erased an early to drop to rise 140 points, or 0.4%, to 34,226, as of 3:47 p.m. Eastern time, while the Nasdaq composite jumped 2.5%.

As expected, the Fed raised its benchmark interest rate by 0.25 percentage points to its highest level since late 2007. It’s the smallest such increase in the Fed’s blizzard of rate hikes since March.

What’s more important for markets is where interest rates are heading next.

Much of Wall Street is hoping that cooling inflation since the summertime means the Fed may raise rates just a bit more, before taking a pause and then possibly cutting rates toward the end of the year. Rate cuts can ease pressure on the economy and juice investment prices.

The Fed’s Powell did reiterate Wednesday that “ongoing increases” in interest rates will be needed to bring down inflation to the Fed’s target level. And he said it was still way too early to declare victory over inflation.

But he also said, “We can now say, I think for the first time, that the disinflationary process has started.” That got Wall Street thinking about a future with no more rate increases.

Higher interest rates try to snuff out inflation by slowing the economy and dragging on prices for stocks and other investments. The Fed has already pulled its key overnight rate to its highest level since 2007, at a range of 4.50% to 4.75%, up from virtually zero early last year.

At stake is the economy, which many investors see likely heading down one of two paths: either a relatively short and shallow recession or a much deeper and more painful one. Building hopes for the former helped stocks rally through January to a strong start of the year.

“My base case is that the economy can return to 2% inflation without a really significant downturn or really big increase in unemployment,” he said. “That’s a possible outcome. I think many forecasters would say it's not the most likely outcome, but I would say there’s a chance of it.”

He also said he did not foresee cutting rates this year.

Others in the market are not as optimistic. A third pathway for the economy is also possible, said Rich Weiss, senior vice president at American Century Investments: one that happened during the 1970s where inflation reignited after the Federal Reserve let up on interest rates too soon.

“We’re headed into a recession one way or the other, whether the Fed eases up on the brakes or not,” Weiss said. “So you might as well kill inflation while you’re doing it. I think it’s nonsensical to think the Fed is going to magically take their foot off at exactly the right time and slide into a short and shallow downturn and the stock market will come through unscathed.”

One area influencing expectations for the Fed is the job market, which has remained resilient despite all of last year’s rate hikes. While strength there helps workers, a worry is that it could lead to too-high gains in wages that give inflation more fuel.

Reports on Wednesday gave a mixed picture on hiring. Private payrolls rose by 106,000 in January, according to ADP. That’s a slowdown from growth of 253,000 a month earlier, and it was well below the 170,000 that economists expected.

But a separate report from the U.S. government indicated more strength. It said the number of job openings increased to 11 million in December, better than the slowdown to 10.3 million that economists expected. The more comprehensive report on the U.S. job market will arrive on Friday.

Adding to the mixed picture on the economy was a report from the Institute for Supply Management, which said U.S. manufacturing weakened by more than expected last month. It was the third straight month of contraction.

Treasury yields fell as Powell spoke, an indication of expectations for an easier Fed.

The two-year yield, which tends to track expectations for the Fed, fell to 4.08% from 4.21% late Tuesday. The 10-year yield, which helps set rates for mortgages and other important loans, fell to 3.39% from 3.51% late Tuesday.

A lackluster earnings reporting season also continues on Wall Street, with more mixed profit reports arriving from big U.S. companies.

Electronic Arts tumbled 9.9% after it gave forecasts for upcoming results that fell short of Wall Street’s expectations. Analysts said some gamers may be getting more selective given the softening economy.

WestRock, a paper and packaging company, dropped 14.1% after it reported weaker earnings and revenue for the latest quarter than expected. It also axed its forecasts for this fiscal year, citing uncertainty about the economy.

On the winning side was Advanced Micro Devices, which rose 12.7% even though its profit tumbled 98% in the fourth quarter from a year earlier. Its results were better than analysts expected.

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AP Business Writers Joe McDonald and Matt Ott contributed.