Historically, the Federal Reserve has helped induce recessions through such interest rate increases. Going into last year, the widespread expectation on Wall Street was that this would happen again.
But this time it was different, or at least it has been so far. The economy continues to grow, the unemployment rate remains remarkably low, and optimism is rising among American households.
"I don't think this cycle is normal at all," said Niladri "Neel" Mukherjee, chief investment officer of TIAA's Wealth Management team. "It's unique and the pandemic introduced that element of uniqueness."
After skyrocketing when tangled supply chains caused shortages due to COVID-19 shutdowns, inflation has been cooling since its peak two summers ago. It has eased so much that the biggest question on Wall Street now is when the Federal Reserve will start cutting interest rates.
Such rate cuts can act as steroids for financial markets, while releasing pent-up pressure on the economy and financial system.
Treasury yields have already eased significantly on expectations of rate cuts, and that helped the stock market rally accelerate sharply in November. The yield on the 10-year Treasury note fell to 4.13% on Friday, and is well below the 5% it hit in October, which was its highest level since 2007.
Of course, some critics say Wall Street has gotten ahead of itself once again in predicting how soon the Federal Reserve could begin cutting interest rates.
"The market is addicted to rate cuts," said Rich Weiss, chief investment officer of multi-asset strategies at American Century Investments. "They just can't get enough and are myopically focused on it."
Repeatedly since the Federal Reserve began this rate-hiking campaign in early 2022, traders have rushed to forecast an upcoming rate easing, only to be disappointed when high inflation turned out to be more persistent than expected. If that happens again, the big moves up in stocks and down in bond yields may need to be reversed.
This time, however, the Federal Reserve itself has hinted that rate cuts are coming, although some officials have indicated they could begin later than the market expects. Traders are betting that the Fed will start cutting in March, almost on the horizon, according to data from CME Group.
"The truth is probably somewhere between what the Fed says and what the market expects," said Brian Jacobsen, chief economist at Annex Wealth Management. "That will continue to cause falls and tears" in the financial markets "until the two reconcile."
Some encouraging data came Friday after a preliminary report from the University of Michigan suggested that the mood among American consumers is improving. He said confidence jumped to its highest level since July 2021. That's important because consumer spending is the main driver of the economy.
Perhaps most importantly for the Fed, expectations of future inflation among households also appear to be anchored. A major concern has been that such expectations could take off and trigger a vicious cycle that keeps inflation high.
Friday's advance on Wall Street came with a big boost from technology stocks, something that has become typical of their bull run.
Several chip companies rose for a second straight day after chipmaker Taiwan Semiconductor Manufacturing Co. delivered a better-than-expected revenue forecast for this year. Broadcom rose 5.9% and Texas Instruments rose 4%.
In total, the S&P 500 rose 58.87 points to reach its record. The Dow Jones Industrial Average set its own record a month earlier and gained 395.19, or 1.1%, on Friday to 37,863.80. The Nasdaq Composite jumped 255.32, or 1.7%, to 15,310.97.
Last year, a few big technology companies were responsible for the vast majority of the S&P 500's gains. Seven of them accounted for 62% of the index's total return, according to S&P Dow Jones Indices.
Many of those stocks (Microsoft, Apple, Alphabet, Nvidia, Amazon, Meta Platforms and Tesla) caused a stir in the market around technology related to artificial intelligence. The hope is that AI will create a boom in profits, both for the companies that use it and those that provide it with the hardware.
Investors may have wanted to stick with just those stocks, which were nicknamed โthe Magnificent 7.โ But some of them remain below their all-time highs, like Tesla. It is still 48% below its all-time high set in November 2021.
Friday's return of the S&P 500 to a record high serves as another example that investors who are patient and spread out their investments in the U.S. stock market end up recouping all of their losses. Sometimes it can take a long time, like in the lost decade of 2000 to 2009, when the S&P 500 crashed during the bursting of the dot-com bubble and the global financial crisis. But historically the market has won back investors, if given enough time.
Including dividends, investors with S&P 500 index funds already broke even a month ago.
Of course, risks still remain for investors. In addition to uncertainty about when the Federal Reserve will begin cutting interest rates, it is also not certain that the economy will avoid a recession.
Interest rate increases take a notoriously long time to fully pass through the system, and can cause things to break in unexpected places within the financial system.
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AP writers Matt Ott and Zimo Zhong contributed.
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