Silke Mayr Next week’s inflation report is set to challenge the recent U.S. stock market rally and influence Federal Reserve rate plans. As of midday Friday, CME FedWatch data showed a 90% chance the Fed would cut rates by 25 basis points.
The S&P 500 was poised for its third consecutive weekly gain on Friday, with its year-to-date advance exceeding 27%. This optimism reflects expectations of more Fed rate cuts and a resilient economy. Historically, this combination has supported strong stock market growth.
Friday’s employment report reinforced the bullish narrative. Job growth surpassed expectations, but the data didn’t suggest significant changes to the labor market. As a result, the Fed is unlikely to alter its rate plans at its December 17-18 meeting.
CPI Report and Inflation Concerns
Wednesday’s consumer price index (CPI) data could shift this outlook. Inflation above expectations may challenge the stock rally and unsettle markets. “If inflation comes in hot, it could be tough for the market to digest,” said Matthew Miskin of John Hancock Investment Management.
November payroll data strengthened bets on a December rate cut. The U.S. economy added 227,000 jobs, though the unemployment rate ticked up to 4.2%. According to Molly McGown of TD Securities, there is now a “higher bar” for the CPI report to alter the Fed’s plans.
CPI is expected to show a 2.7% annual increase through November. A higher-than-expected figure might prompt a “hawkish cut,” signaling fewer rate reductions in 2025, said Miskin. Inflation concerns are heightened by President-elect Donald Trump’s proposed tariff hikes, which could boost prices.
TD Securities anticipates a pause in rate cuts in early 2024 as the Fed evaluates Trump’s fiscal policies. “Once the Fed understands the details of these policies, they’ll adjust their monetary strategy,” McGown explained.
Stock Market Valuation and Sentiment
Despite rate and inflation concerns, stocks have continued their upward trajectory. The S&P 500 traded at 22.6 times expected earnings, the highest valuation in over three years.
However, some analysts warn of overly optimistic sentiment. Yardeni Research pointed to bearish contrarian indicators, including bullish investment advisor sentiment and foreign purchases of U.S. stocks.
Still, many investors remain optimistic. The year-end period is traditionally strong for equities, suggesting continued momentum despite potential headwinds.