An inflation report due next week may challenge the U.S. stock market’s record-breaking rally. The data will also play a key role in shaping the Federal Reserve’s decisions on interest rate cuts.
The S&P 500 was heading for its third consecutive weekly gain on Friday, boosting its year-to-date increase to over 27%. This strong market performance reflects optimism about additional Fed rate cuts amid a resilient economy. Historically, this combination has driven significant equity gains.
Consumer Prices and Fed Rate Cuts
The upcoming consumer price index (CPI) report, expected on Wednesday, is critical. A higher-than-anticipated inflation rate could disrupt the positive market sentiment. “If inflation comes in hot, the stock market may face a tough challenge,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management.
The November jobs report supported expectations for a Fed rate cut, showing 227,000 jobs added, despite a slight increase in the unemployment rate to 4.2%. Fed fund futures suggest a 90% likelihood of a 25-basis-point rate cut at the December 17-18 meeting, according to CME FedWatch.
Molly McGown, U.S. rates strategist at TD Securities, stated that the CPI report would face a “higher bar” to halt the anticipated rate cut. Analysts expect a 2.7% year-over-year CPI increase for November, based on Reuters data.
If inflation surpasses estimates, the Fed might take a “hawkish cut” approach, signaling fewer rate reductions in 2025. President-elect Donald Trump’s proposed tariffs could further fuel inflation concerns.
Market Optimism Faces Caution
As the Fed evaluates its policy, the stock market‘s strong performance continues. The S&P 500 traded at 22.6 times its expected earnings for the next 12 months, the highest price-to-earnings ratio in over three years. However, some analysts warn of excessive optimism.
Yardeni Research flagged bearish contrarian indicators, including bullish sentiment among advisors and increased foreign purchases of U.S. stocks. Still, others remain optimistic, citing the historically strong year-end period for equities.
Fed Chair Jerome Powell emphasized that any adjustments to monetary policy would depend on clarity regarding fiscal policies under the new administration. Until then, markets and policymakers alike are preparing for potential shifts in economic conditions.