Wall Street’s fear gauge drops to a 4-week low as expectations for less-aggressive Fed rate hikes fuel stock gains

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US stock market traders
Friday’s inflation print shocked investors.

  • Wall Street’s so-called fear gauge hit a one-month low Tuesday as stocks rose amid speculation the Fed will reduce the size of future rate hikes. 
  • The Cboe Volatility Index fell by more than 4% to its lowest level since September 23. 
  • Investors have latched onto signs the Fed may downshift rate hikes from the current size of 75 basis points. 

Speculation that the Federal Reserve will reduce the size of future rate hikes has lifted stocks and driven the US market’s so-called fear gauge down to a one-month low. 

The Cboe Volatility Index, a widely watched track of the 30-day implied volatility of the S&P 500 index, fell 4.5% to 28.49, the lowest level for the VIX since September 23. 

Meanwhile, the S&P 500 notched a third consecutive gain as did the Dow Jones Industrial Average and the Nasdaq Composite

Risk appetite in the current bear market was ignited Friday as investors latched onto signs that the Federal Open Market Committee may opt to downsize interest rate increases after its meeting in November. The Fed has already raised rates this year to a range of 3% to 3.25% from near zero to combat high inflation and by 75 basis points at each of its past three meetings. 

“Markets have continued their upbeat tone despite continued warning signs over the economic difficulties ahead. Rising rates will likely bring unwelcome consequences, but markets are at least appearing positive at the thought that central banks will soon see their tightening phase run its course,” Joshua Mahony, senior market analyst at online trading platform IG, said in a Tuesday note. 

Investors began slashing the odds of a 75-basis-point rate hike in December and beyond after a Wall Street Journal report and separate comments from San Francisco Federal Reserve President Mary Daly suggested policymakers are considering a step-down from jumbo rate hikes. 

The CME FedWatch tool on Tuesday showed expectations locked in for a rate hike of 75 basis points at the Fed’s November 1-2 meeting. But on Tuesday, the probability of another hefty rate increase in December fell to 50.4% from 54.9% a day ago, and from 64.3% a week ago. 

Softening economic data that support the argument for the Fed to downshift its tightening pace as well as a fresh round of “decent” corporate earnings reports also helped push stocks higher on Tuesday, Oanda senior analyst Ed Moya said in a note.

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