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Market Outlook: Fed's Stance On Inflation Doesn't Worry Investors

The Federal Reserve's continued concern about inflation hasn't dampened the bullish sentiment for stocks.

In fact, many market pros think inflation will continue to moderate, giving the central bank room to begin cutting interest rates later this year.

As expected, Fed policymakers on Wednesday left interest rates unchanged at 5.25% and said inflation remained its predominant concern, making a cut in interest rates unlikely--at least in the near-term.

"There wasn't any real surprise in their announcement, although one would have hoped they would be softer on inflation," John Manley, private client strategist for Smith Barney, told CNBC.com.  "But it's important that the market believes the Fed is vigilant on inflation.  I'm looking for a higher market at the end of the year and nothing I heard today changes that."

After the Fed decision, the Dow continued its stampede to yet another record close. The Dow has now risen 25 of the last 29 trading days. Traders said M&A activity and corporate buybacks fueled Wednesday's runup and those factors will likely continue to drive the markets.

Rally Isn't Over

"I think you saw a lot of money that was put on the sidelines earlier in the day, waiting for the Fed event to take place, then finally coming to the market after there was no major change from the Fed," said Jeffrey Kleintop, chief market strategist for LPL Financial Services. "I don't think the rally is over yet and I think the rally at the end of the day today supports that."

"There's just a lot of money around and a lot of it comes from the other side of our trade deficit," said Manley. "But the stock market probably has not gotten its full share of that liquidity. I don't see anything that tells me this tremendous liquidity is going away and it may be more directed at the U.S. stock market."

Recent economic data, including moderate wage and price increases, have suggested that inflationary pressures are on the decline. Although core inflation has not dropped to the 2% mark that the Fed would prefer, many analysts still believe moderating inflation and a slowing economy will lead to a rate cut by the end of the year.

"This, in a sense, is their last gasp meeting where they really, really take a hard line on inflation," said William Gross, chief investment officer of PIMCO. "At some point, they've got to give up that ghost and start to acknowledge that inflation is coming down to where they want it to come."

Rate Cut Expected

"As inflation comes back in line later this year, as we're expecting, and if the economy continues to weaken, which we are also expecting, we think the Fed will take some action to cut by the end of the year, or maybe early next year," said Vanguard Portfolio Manager Ken Volpert.

In the coming weeks, analysts will be looking at much of the data that the Fed is monitoring, trying to determine how much the economy is slowing and whether inflation is really in check.

"I think you have to look at the housing numbers," said Manley.  "If you examine what caused the slowdown, there's nothing to indicate it will rip through the economy. We will also be looking at wage growth.  We keep an eye on wages because no real inflation cycle can begin without wage increases."

"The Fed needs to see slower employment growth and higher unemployment," said Gross. "We haven't seen that yet."