It's Make-or-break Time for the Stock Market Rally

A considerable period has passed since a robust inflation report triggered significant fluctuations in U.S. stocks, as frequently observed in 2022. However, this does not imply that the upcoming consumer price index (CPI) report for October, scheduled for Tuesday, will be uneventful for the markets.

On the contrary, some analysts on Wall Street suggest that the October CPI report could serve as a pivotal catalyst for stocks, potentially driving the market higher if the numbers are softer than expected. Renowned economist Neil Dutta from Renaissance Macro Research even anticipates the possibility of a negative CPI inflation print for October. Dutta points to the decline in retail gasoline and heating oil prices over the month, suggesting that energy, though a small portion of total CPI (approximately 7%), can significantly influence month-to-month swings.

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The timing of the October CPI report is crucial for the markets, as investors are keenly awaiting signals about whether the Federal Reserve will proceed with another interest rate increase, as indicated in its projections released in September. Federal Reserve Chairman Jerome Powell, in a recent statement, left the possibility open for another move but emphasized that the decision would depend on the data.

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Thierry Wizman, Macquarie’s global FX and interest rate strategist, highlights the importance of the upcoming CPI data, suggesting that the Fed is likely to be highly reactive to the data rather than anticipatory. The report could have a calming effect on markets, especially if a low headline CPI result diminishes concerns about excessive wage demands in the labor market.

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Reflecting on the potential impact of a soft inflation report, market analyst Tom Lee refers to the June CPI report and its positive influence on stocks, leading to the S&P 500 reaching its 2023 closing high in July. Lee suggests that inflation would need to significantly reaccelerate to adversely affect the stock market.

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The current market scenario indicates that the risks for investors heading into Tuesday's report are likely tilted to the upside. Even if the numbers are slightly hotter than expected, it may not be enough to derail the market's November rebound rally. On the other hand, a soft reading could reinforce expectations that the Fed is done hiking rates, potentially leading to a rally in both stocks and bonds.

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Given the shift in the reaction function of the stock market, as noted by Lee, the market is expected to view a slightly hotter-than-expected CPI number differently than in previous instances. U.S. inflation has considerably eased since peaking above 9% on a year-over-year basis last summer, and the upcoming CPI report may offer insights into investors' expectations for the "last mile" in driving inflation down to the Fed's 2% target.

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While economists expect consumer prices to rise 0.1% in October, and core prices, excluding volatile food and energy, to increase by 0.3%, the CPI report isn't the sole piece of market-moving news in the coming week. Other economic reports, including housing-market and manufacturing activity readings, along with the producer-price index, will also contribute to shaping market sentiment.

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Since the beginning of 2023, the S&P 500 index has not witnessed a single move of 1% or greater on a CPI release day, marking a departure from the significant daily swings seen in 2022. The recent rise in U.S. stocks since the start of November further underscores the significance of the upcoming CPI report.