(Bloomberg) — A month after the stock market was rocked by a worse-than-expected inflation report, investors are fearing a repeat when the latest data arrives on Tuesday.
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Despite last week's sideways price action, the S&P 500 Index is on the rise, rising in 16 of the last 19 weeks, driven by improving earnings prospects and a robust U.S. economy. The general stock benchmark has not performed better since 1964. But some of those gains could be wiped out if the monthly consumer price index continues to show inflation remaining stubborn.
“The economic data raises more questions than answers about how long it will take for the Fed to gain more confidence in improving inflation,” Thomas Martin, senior portfolio manager at Globalt Investments, said by phone. “Stocks have had a strong year so far, but have they come too far too fast? Probably.”
To get a sense of what's at stake, take a look at last week's trading. The S&P 500 gained 1% on Thursday as Federal Reserve Chairman Jerome Powell said in Senate testimony that the central bank is “not far” away from cutting interest rates. On the same day, Powell's European counterpart Christine Lagarde said the European Central Bank could start cutting interest rates as early as June, sending the Stoxx Europe 600 index up 1.3%. For traders obsessed with profits lately, it was a reminder of how powerful the prospect of interest rate cuts is.
While the S&P 500 has fallen on just four CPI reporting days in the last 12 months, volatility in those sessions is increasing this year. According to data compiled by Bloomberg, as of the day the CPI was released, the S&P had moved about 0.8% in either direction over the past six months. That's the highest since April and up from less than 0.5% in September.
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With Fed officials in lockdown ahead of their meeting on March 19-20, traders are looking for clues about the health of the U.S. economy and the central bank's path forward. In addition to the consumer price index, data on producer prices, retail sales and consumer sentiment must also be available before policymakers meet.
“We will likely see more volatility until further inflation numbers improve,” Martin said.
Financial markets are bracing for the possibility that the Fed could keep borrowing costs high for longer than hoped, putting a rate cut in May in doubt. A separate report on Friday showed that employers continue to add jobs without spurring a rise in wages, which could hamper the disinflation process.
Many retailers still remember the last consumer price index on February 13, which showed that core U.S. consumer prices rose the most in eight months. That sent the S&P 500 down 1.4%, the worst consumer price index since September 2022, according to data compiled by Bloomberg.
The reaction showed that the market is once again reacting more sensitively to inflation reports. Over the past year, stocks have had a relatively muted response to consumer price signals as inflation eased.
“CPI data has mostly improved in recent months, although the rate of decline has slowed somewhat,” said Michael Sheldon, managing director of RDM Financial Group. “Investors are likely to continue to be more optimistic that inflation is slowing, although it could certainly take longer than some would have liked.”
In testimony to Congress last week, Powell reiterated that the central bank was in no rush to cut interest rates until policymakers were confident they had contained inflation. The economy and labor market remain strong, meaning the Fed still has time to wait for clearer signs that inflation is moving back toward policymakers' 2% target before cutting interest rates.
Tuesday's CPI report is expected to show prices rising 0.4% from January to February, with key headline inflation expected to remain unchanged from the previous month. The core CPI, which excludes the volatile food and energy components and is considered a better underlying indicator than the main measure, is expected to rise 0.3% month-on-month and 3.7% year-on-year.
“It's impressive that stocks outperformed last month's higher-than-expected inflation,” said Yung-Yu Ma, chief investment officer at BMO Wealth Management. “But if there are several months in a row of unfavorable data, that will test the stock market's ability to look past it and further question whether this year's rally needs to consolidate soon.”
– With support from Elena Popina.
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