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There’s a reason why stocks are moving higher — and it’s not just because of earnings

Scott Gamm
Tommy Kalikas, right, works with fellow traders on the floor of the New York Stock Exchange during the Brigham Minerals IPO, Thursday, April 18, 2019. U.S. stock indexes wavered between modest gains and losses in midday trading Thursday as another slide in health care sector companies offset gains elsewhere in the market. (AP Photo/Richard Drew)

Corporate earnings are coming in better than expected. But that’s not the only factor responsible for the S&P 500’s (^GSPC) record high earlier this week.

Investors are increasingly pricing in a more dovish Fed, according to Wall Street research shop DataTrek Research.

Data from CME’s FedWatch tool shows investors are increasingly pricing in higher odds of an interest rate cut.

In March, the Fed downgraded its prior 2019 rate hike guidance to zero hikes, compared to a forecast of two, which was released in December of 2018.

For the Fed’s June 2019 meeting, investors are pricing in a 21% chance of a rate cut, up from 7% a week ago.

For July, investors are pricing in a 28% chance of a cut, compared to 10% a week ago.

December is perhaps most striking, with investors seeing a roughly 60% chance of a rate cut, compared to over 40% a week ago.

Lower rates make stocks more attractive. Stocks are back at their September 2018 record highs - although the 10-year Treasury yield is only 2.5%. In September 2018, the 10-year Treasury yield was over 3%. A big culprit of the stock market selloff during the fourth quarter of 2018 was worry that the Fed was raising interest rates too aggressively.

“We think this shift in market expectations for Fed policy is at least as important to the recent run-up in U.S. stocks as better-than-expected earnings reports,” wrote Nick Colas, co-founder of DataTrek Research in a note to clients.

While it may seem like increased expectations of a rate hike mean the U.S. economy is weakening (because the Fed tends to cut rates during times of distress), the analysts point to a lack of inflation as the real culprit for lower rate expectations.

“There is clearly some concern at the Fed that core inflation remains below the central bank’s 2% target rate, meaning that monetary policy is currently too restrictive,” Colas wrote.

The core personal consumption expenditure price index, as of its latest reading for January, only rose 1.8% year-over-year.

Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.

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