- It is increasingly likely that inflation has peaked and is set to fall considerably, according to JPMorgan.
- That means the economy is more likely to stick a soft landing as the Fed slows down its interest rate hikes.
- "We feel the uptick in risk appetite is justified on a more fundamental basis," JPMorgan said.
The chances of a soft economic landing have increased considerably in recent weeks as inflation shows signs of cooling off, JPMorgan said in a Wednesday note.
A stronger than expected jobs report, combined with a weaker than expected July CPI report has bolstered the view of JPMorgan's Marko Kolanovic that inflation will get cut in half in the latter part of this year.
"The breadth of US inflation has improved from June with not only energy but apparels, education and communication commodities and services and transportation services," Kolanovic said, adding that the percentage of countries with rising core inflation has moved down from 80% to 70%.
"Hence, there is evidence that a peak in inflation is not a US-specific development," Kolanovic said, adding that he expects global inflation to fall 50% to just 4.7% in the second half of the year.
If inflation continues to cool down, which is likely given the continued drop in oil and agricultural commodity prices, then it is increasingly likely that the Federal Reserve has reached peak hawkishness and is set to slow down its interest rate hike trajectory.
"Effectively, the milder than expected CPI print reduces tail risk of a [Fed] policy mistake," Kolanovic said. Current expectations for the Fed include a 75 basis point rate hike in September, followed by smaller 25 basis point rate hikes in November and December.
A peak in inflation, a peak in Fed hawkishness, and a strong underlying jobs market all means that the stock market can see continued upside into year-end, according to the note.
"We feel the uptick in risk appetite is justified on a more fundamental basis even if many have attributed the recent improvement in market sentiment to technical factors, short-covering, or 'bear market rally,' with moves magnified by already low liquidity and positioning," Kolanovic said.
Stronger than expected corporate earnings in the second quarter have also helped improve investor sentiment, and the could be further room to the upside based on the results of the upcoming midterm election.
"Despite a high likelihood of a divided government, the silver lining is that risk markets like gridlock so we shouldn't be too surprised if this eventually turns out to be a pro-risk development," Kolanovic said.