Stock Market Rally Faces Critical Test Ahead
As the US stock market continues to soar, reaching new heights with a 27% year-to-date advance, a crucial inflation report looms on the horizon. This critical data point could make or break the market’s momentum and influence the Federal Reserve’s decision on interest rate cuts.
A Rosy Backdrop for Stocks
The current economic landscape appears favorable for stocks, with expectations of further Fed rate cuts and a resilient economy. Historically, this scenario has led to strong equity gains. Friday’s employment report, which showed stronger-than-expected monthly job growth, supports this narrative. However, the data is unlikely to signal a significant shift in labor market conditions that would cause the Fed to reassess its rate trajectory.
Inflation Report: A Wild Card
But the upcoming consumer price index (CPI) report, due on Wednesday, could disrupt the optimistic outlook if inflation rates exceed expectations. A higher-than-anticipated CPI reading could pose a challenge for high-flying stocks, introducing uncertainty ahead of the Fed’s December meeting. According to Matthew Miskin, co-chief investment strategist at John Hancock Investment Management, “If you come in hot, I do think that’s going to be tough for the stock market to digest.”
Fed’s Rate Cut Plans
Following the November payrolls report, bets on the Fed cutting rates at its next meeting have firmed up. Fed fund futures trading indicates a nearly 90% chance of a 25-basis-point cut. However, if the CPI report comes in hotter than expected, the central bank might implement a “hawkish cut” by tempering expectations for future rate reductions.
Tariffs and Inflation
President-elect Donald Trump’s plans to raise tariffs on imports could also revive inflation concerns. Tariffs are expected to be inflationary, and TD Securities predicts the Fed will pause rate cuts at the start of the year to assess Trump’s fiscal policies.
Stock Market Sentiment
Meanwhile, stocks continue to surge, raising concerns about overly optimistic sentiment. The S&P 500’s price-to-earnings ratio has reached its highest level in over three years, according to LSEG Datastream. Yardeni Research notes bearish indicators, such as high bullish sentiment among investment advisors and foreign private purchases of US stocks. Yet some investors remain optimistic about the prospects for stocks into year-end, citing eased bear arguments and a seasonally strong period for equities.
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