The Federal Reserve is expected to cut rates by 25 basis points at its upcoming meeting, with Fed fund futures on Friday reflecting a nearly 90% probability of this move, according to CME FedWatch. However, next week’s inflation report could challenge the record-breaking U.S. stock rally by providing crucial data for the Fed’s rate decisions.
The S&P 500 has climbed over 27% this year, heading for its third consecutive weekly gain. This strong rally is fueled by expectations of further Fed rate cuts and a resilient economy. Historically, this combination has supported equity gains. Friday’s employment report, showing stronger-than-expected job growth, reinforced this optimistic scenario without altering the Fed’s expected rate trajectory for its December meeting.
Inflation Data: A Potential Market Turning Point
Consumer price data due Wednesday could disrupt the positive market sentiment if inflation surpasses expectations. “If inflation comes in hot, the market might struggle to digest the news,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management. This uncertainty could impact stocks ahead of the Fed’s decision.
November’s payroll data revealed 227,000 new jobs and a slight rise in unemployment to 4.2%. This strengthened bets on a rate cut. Molly McGown, a U.S. rates strategist at TD Securities, noted that the consumer price index (CPI) would face a “higher bar” to pause any planned rate cut.
The CPI is projected to rise 2.7% year-over-year through November, according to Reuters. If inflation exceeds expectations, the Fed might execute a “hawkish cut” by signaling fewer rate reductions in 2025, Miskin explained. Inflation concerns are further heightened by President-elect Donald Trump’s proposed tariff increases, which could amplify inflationary pressures.
Fed’s Approach and Stock Market Sentiment
TD Securities predicts the Fed will pause rate cuts early next year to evaluate Trump’s fiscal policies. McGown highlighted that Fed Chair Jerome Powell has emphasized waiting for clarity on policy impacts before adjusting monetary strategy.
Despite rising stocks, some analysts warn about excessive market optimism. The S&P 500’s price-to-earnings ratio has hit 22.6 times expected earnings, the highest in over three years. Yardeni Research flagged concerns over bullish sentiment among advisors and increased foreign purchases of U.S. stocks, calling such signals “contrarian indicators.”
Still, many investors remain optimistic, expecting stocks to perform well in the seasonally strong year-end period.