Why Inflation Data This Week Matter with Stocks Near Record Highs

Investors are heading into one of the most important economic weeks of the summer as fresh inflation readings arrive in the form of the Consumer Price Index (CPI) on Wednesday, August 12 and the Producer Price Index (PPI) Thursday.

Both reports are likely to have an outsized impact on interest rate expectations, Treasury yields, and equity markets. This week's inflation reports arrive during a period when investors are weighing a few competing narratives: positive earnings and a resilient economy versus lingering price pressures and a diverging Fed. Employment remains solid, corporate earnings have been supportive, and equity markets have shown continued strength. However, inflation remains the key risk that could alter the Federal Reserve's path.

The market's reaction may depend less on the headline numbers themselves and more on whether the data changes expectations for future Fed policy. If inflation continues to trend lower, investors could gain confidence that the disinflation story remains intact. If price pressures reaccelerate, concerns about higher-for-longer interest rates may quickly return.

Stocks kicked off August with a bang led by gains in the tech sector. The S&P 500 (SPX) rose 3.6% last week while the Nasdaq-100 (NDX) rallied 5.1%. The Dow Industrial Index ($DJI) rose 3% last week, and the small-cap Russell 2000 (RUT) jumped 3.5%. The S&P 500, Dow Index and Russell 2000 all hit record intraday highs this past week and the optimism for “risk-on” assets has surged. Falling yields and oil prices positively impacted equity markets last week, and earnings beats continued to cement the bullish momentum.

With markets just below record highs, the inflation data comes at a crucial time. Following the latest Federal Reserve meeting in July, investors remain focused on whether inflation is cooling enough to allow policymakers to contemplate future rate cuts or whether price pressures remain stubbornly elevated. Three Fed members voted for a 25-basis-point rate hike at the July FOMC meeting with stubborn inflation above its 2% mandate. The inflation trends could determine the direction of stocks, bonds, and sector leadership for the remainder of August into the Fed’s September meeting.

Here are some movements from last week to watch:

• Yields pulled back this past week after oil prices fell, and the July nonfarm payrolls data came in lighter than expected.
• Crude prices fell about 11% last week and settled near $78 a barrel.
• The July jobs report showed an unexpected loss of 23,000 jobs, which was far below the expected rise of 85,000 and reflected the softening labor market.
• The unemployment rate fell to 4.1% as the labor force participation rate fell to its lowest level in more than five years.
• The benchmark 10-Year yield fell 11 basis points last week to settle near 4.66% after topping at over 1.5-year highs at the end of July.

This asset movement led to a decrease in expectations of a rate hike in September. According to the CME FedWatch Tool on Friday, expectations fell to about 44% for a 25-basis-point hike at the September meeting, which is down from over 55% from the prior week.

Looking ahead, the inflation data could be a catalyst this week. The most recent CPI report showed prices falling 0.4% month-over-month in June, while headline inflation remained up 3.5% from a year ago, far above the Fed’s 2% mandate. Core CPI, which excludes food and energy, was up 2.6% year-over-year and was unchanged on a monthly basis. While the data was below expectations, investors want to see the trend continue; the Fed continues to rely on that based on their recent comments.

Economists expect the July headline Consumer Price Index (CPI) to be 3.4% year-over-year and core CPI to increase 2.5% annually. Investors will be looking for signs that July inflation continued to moderate. A softer-than-expected report would reinforce the view that inflation is trending toward the Fed's long-term target and could bolster expectations for future policy easing and not rate hikes. Conversely, an upside surprise would likely renew concerns that inflation remains too persistent.

Economic Calendar, Monday, Aug. 10:

• 11:30 AM: 3 and 6-Month Bill Auctions

Earnings Snapshot, Monday:

• Premarket: Barrick Mining Corporation (B)
• Postmarket: Simon Property Group (SPG), Rocket Lab Corporation (RKLB), AST SpaceMobile (ASTS), Hims & Hers Health (HIMS), Archer Aviation (ACHR), Plug Power (PLUG), Quantum Computing (QUBT)

This material is intended for informational purposes only and should not be considered a personalized recommendation or investment advice. Investors should review investment strategies for their own particular situations before making any decisions.

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