(Bloomberg) — A month after a weaker-than-expected inflation report spooked the stock market, the latest data released Tuesday has investors worried about a backlash.
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Despite last week's sideways movement, the S&P 500 index has risen and fallen sharply in 16 of the past 19 weeks on the back of an improving earnings outlook and a resilient U.S. economy. Not since 1964 have broad stock benchmarks performed this well. But some of those gains could be reversed if monthly consumer price index readings continue to show that inflation is stubbornly persistent.
“Economic data is starting to raise more questions than answers about how long it will take for the Fed to become more confident that inflation is improving,” Thomas Martin, senior portfolio manager at Globalt Investments, said by phone. “I'm there,” he said over the phone. “Stocks have done well so far, but have they progressed too quickly? Probably.”
Look at last week's trading to see what's going on. The S&P 500 rose 1% on Thursday when Federal Reserve Chairman Jerome Powell said in Senate testimony that the central bank was “not far off” from preparing to cut 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 who have been obsessed with earnings lately, this served as a reminder of how strong the prospect of a rate cut is.
Over the past 12 months, the S&P 500 index has fallen on just four CPI release days, but these sessions have been more volatile this year. Over the past six months, the S&P has moved about 0.8% in either direction on CPI release dates, according to data compiled by Bloomberg. This is the highest since April and up from less than 0.5% in September.
Fed officials are on a blackout ahead of their March 19-20 meeting, with traders looking for clues about the health of the U.S. economy and the Fed's future direction. In addition to the CPI, data on producer prices, retail sales and consumer sentiment are all expected to be submitted before policymakers meet.
“Until we see further improvement in inflation data, we will continue to see more volatility,” Martin said.
Financial markets are wary of the possibility that the Fed could keep borrowing costs high for longer than expected, calling into question its May interest rate cut. A separate report on Friday showed that employers continue to create jobs without spurring wage increases, which could hinder the disinflation process.
Many traders still remember the last CPI data on February 13th, which showed that US core consumer prices rose the most in eight months. That sent the S&P 500 down 1.4%, the index's worst CPI day since September 2022, according to data compiled by Bloomberg.
This reaction showed that the market is once again becoming sensitive to inflation reports. Last year, stock prices reacted relatively modestly to consumer price signals as inflation receded.
“CPI statistics have mostly improved in recent months, but the rate of decline has slowed slightly,” said Michael Sheldon, executive director of RDM Financial Group. “It's certainly possible that it will take longer than some people had hoped, but investors are likely to remain optimistic that inflation is slowing.”
Powell reiterated in Congressional testimony last week that the central bank would not rush to cut rates until policymakers were confident they had succeeded in curbing inflation. The economy and labor market remain strong, meaning the Fed has leeway to wait for clear evidence that inflation is returning to policymakers' goal of 2% before cutting rates.
Tuesday's CPI report showed prices are expected to rise 0.4% in January-February, with key headline inflation expected to remain unchanged from the previous month. Core CPI, which removes volatile food and energy components and is considered a better underlying measure than the main index, is expected to rise 0.3% month-on-month and 3.7% year-over-year.
“It's impressive that stocks have shaken off last month's higher-than-expected inflation,” said Yunyou Ma, chief investment officer at BMO Wealth Management. “However, several consecutive months of unfavorable data will test the stock market's ability to weather this and further call into question whether this year's bull run needs to be consolidated quickly.”
–With assistance from Elena Popina.
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