Why the Next Inflation Report is so Important for the Markets

The U.S. stock market lacks direction, and traders are uncertain about its future trajectory. The stock market in the United States has been pulling down from its recent highs over the last several weeks, and after the nonfarm payroll figures were released, investors grew more hesitant to support risky assets.

The nonfarm payrolls report came in far stronger than predicted, leading market participants to speculate that the Federal Reserve may actually maintain its present rate of interest rate hikes given the robust state of the job market. The number of persons working in nonfarm settings increased by 263,000 throughout the month, according to statistics that were provided by the Labor Department on Friday. However, the unemployment rate stayed the same at 3.7% during the month; investors expected 200,000 jobs to be added and unemployment rate to stay unchanged at 3.7%.

The figure for the previous month had been revised upward to reflect a greater number. Taking into account people who have given up looking for work and people who are working part-time jobs due to economic considerations, a more comprehensive measure of unemployment revealed that the jobless rate had inched down to 6.7%.

Traders got even more cautious this week with the release of the U.S. ISM Services PMI data, which showed a significant increase and a score of 56.5. Simply put, the economic data conveys one obvious message: the U.S. economy is likely to undergo a slight recession, if that. However, in my judgment, the potential of higher interest rates or ultra-hawkish monetary policy remains a significant danger to the U.S. If the Fed does not moderate its rate of interest rate rises; if rates are too high, it will inevitably slam the brakes on U.S. economic growth.

The fact is that the future direction of the U.S. stock market is inextricably related to one economic reading, the CPI statistic, which will be released next week. The report is expected to be released on Tuesday, and the inflation estimate is expected to fall further. This figure fell to 7.7% last month from 8.2% the prior month.

If the U.S. CPI data falls to 7.1% or below, I think the Fed will have little cause to be concerned about inflation. This is because the present inflation trend is in the correct direction, with enough tailwinds to bring the figure further down in the coming months. However, a marginal decline, defined as any amount more than 7.4%, might cause the Fed to maintain its current aggressive monetary policy stance.

To summarize, the CPI statistic is now important. If the U.S. CPI figure continues to show a reasonable downward trend, the Fed is unlikely to raise rates aggressively, since this would needlessly hinder economic development. This scenario would be positive for the U.S. stock market, and the Santa rally may be in full swing.

If the reading does not meet expectations, the Fed may raise interest rates by another 75 basis points, triggering a more severe sell-off in the U.S. stock market. Mark your calendars for Tuesday and be ready for either outcome.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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