US stock markets rallied and the dollar strengthened on Thursday after data showed a strong US economy that is decelerating with slowing inflation, giving credence to the Federal Reserve's desire to engineer a soft landing.

Gross domestic product increased at a faster-than-expected 2.9 percent annual rate in the fourth quarter of last year as consumers boosted spending on goods, the US Commerce Department said.

Inflation data improved too, as personal consumption expenditures growth slowed to 2.1 percent year over year from 2.3 percent in the prior quarter while the GDP price index decelerated to 3.5 percent.

But the Fed's hefty interest rate hikes last year eroded demand and slowed growth toward the end of 2022, posing tough choices for US central bank policymakers as they contemplate how much higher rates need to go when they meet next week.

"The market is pricing in a Fed pivot where they actually cut rates by the end of the year," said James Ragan, director of wealth management research at DA Davidson in Seattle, adding Fed Chair Jerome Powell is unlikely to indicate any move next week.

"What Powell has pushed back on a lot is to not really think about lowering rates at all," Ragan said. "But they are willing to pause and hold rates at a high level for a certain period of time."

The Dow Jones Industrial Average rose 0.6 percent to close at 33,949, the S&P 500 gained 1.1 percent to 4,060 and the Nasdaq Composite added 1.8 percent to 11,512.

Futures are pricing a 94.7 percent probability of a 25 basis points hike next Wednesday and see the Fed's overnight rate at 4.45 percent by next December, or lower than the 5.1 percent rate Fed officials have projected into next year on market expectations of a rate cut.

Treasury yields rose as the resilient economy strengthened the case for the Fed to maintain its hawkish stance in coming months as it seeks to cool inflation.

"On balance, the data being better than expected suggests there's more resilience in the economy than many have given it credit," said Joe Manimbo, senior market analyst at Convera in Washington. "The fact that inflation figures in the Q4 data moderated suggests it's a Goldilocks scenario."

While talk of recession likely is overdone, the market is not cheap, said David Bahnsen, chief investment officer at private wealth manager The Bahnsen Group in Newport Beach, California.

"Investors should not assume that the easy times in the market are coming back," he said. "I don't think people should be in a hurry to go back to excessive risk."

Oil prices rose more than 1 percent on Thursday on expectations demand will strengthen as top oil importer China reopens its economy and on positive US economic data.

US crude futures settled up 86 cents at US$81.01 a barrel, and Brent rose US$1.35 to settle at US$87.47.

Gold edged down after the strong US data. Indications of a likely slowdown limited losses in the safe-haven asset. (Reuters)