By Lewis Krauskopf
NEW YORK (Reuters) – An inflation report next week will test the strength of the record rally in U.S. stocks and provide crucial data that could factor into the Federal Reserve's rate cut plans .
On Friday, the S&P 500 was on track for its third consecutive weekly gain, pushing its year-to-date gain to more than 27%.
The optimistic backdrop for stocks is underscored by expectations of further interest rate cuts from the Fed, even as the economy remains resilient.
This scenario has historically produced strong stock market gains, and it was supported by Friday's jobs report, which showed monthly job growth was stronger than expected. Still, this data is unlikely to signal a significant change in labor market conditions that would cause the Fed to rethink its rate path at its Dec. 17-18 meeting.
However, consumer price data due Wednesday could threaten the optimistic narrative if inflation rates come in higher than expected, posing a challenge for high-flying stocks.
“If you come in strong, I think it's going to be hard for the stock market to digest,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management. “That’s going to bring a bit of uncertainty before the Fed meeting.”
Bets that the Fed would cut rates at its next meeting were borne out after the November jobs report. The data showed an increase of 227,000 jobs, but the unemployment rate climbed to 4.2%.
As of midday Friday, federal funds futures trading indicated a nearly 90% chance that the central bank would cut rates by 25 basis points, according to CME FedWatch.
Following the jobs data, there's a “higher bar” for the next consumer price report to put any planned rate cuts at the next Fed meeting on hold, said Molly McGown, policy strategist. US rates at TD Securities.
The consumer price index is expected to have climbed 2.7% in the 12 months through November, according to Reuters data.
Rather than suspending rate cuts, if the CPI turns out to be higher than expected, the central bank could implement a “hawkish cut” by tempering expectations for cuts in 2025, Miskin said.
The potential for a pick-up in inflation is also being given more consideration due to President-elect Donald Trump's plan to raise tariffs on imports. Prices should be inflationary.
TD Securities expects the Fed to pause its rate cuts early in the year as policymakers evaluate Trump's fiscal policies after he takes office in January, McGown said.
“We heard (Fed Chairman Jerome) Powell say that once they know the actual policies, they will start to incorporate them into their framework to determine what they are going to do with monetary policy,” McGown said.
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