Can the Fed Dial Back Dovish Tone? CPI Data to Test Market Resolve

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Stocks Face Inflation Test amid Renewed Optimism

Next week’s release of the consumer price index (CPI) report will mark the first significant market test since the Federal Reserve (Fed) took a dovish stance on interest rates. Investors remain hopeful, fueled by a strong earnings season, moderated labor data, and stabilizing bond yields.

Inflation’s Impact on Market Sentiment

Inflation data has been a significant driver for market sentiment this year. Investors have been monitoring inflation closely to gauge the Fed’s actions, while reports have shown elevated inflation levels. Stocks fell earlier this year as investors acknowledged the potential time needed for the Fed to curb inflation to its target of 2%.

However, there’s renewed optimism for the upcoming data release, with UBS anticipating a decline in US inflation in the coming months. April’s CPI is projected to rise 0.4% monthly and 3.4% annually, according to FacSet consensus estimates, slightly lower than the previous month’s growth.

How Markets Will React

Investors are closely watching how markets respond to the CPI data, particularly the ICE BofAML MOVE Index, a measure of volatility in the fixed income market. A reading above 100 indicates uncertainty about interest rate expectations and can negatively impact stocks. The index has recently dipped below 100 after the Fed meeting, and investors hope it remains low, even if the CPI prints higher than expected.

Fed Pause and Market Performance

If markets react positively to the CPI data, it could lead to further gains for stocks. Historically, the S&P 500 has averaged a 6% return during Fed pauses, and gains have been even stronger in recent pauses, averaging 13.1%.

Jason De Sena Trennert of Strategas cautions that investors should “fear the cut, not the pause,” as Fed easing is typically associated with economic and market stress. However, he adds that a soft landing by the central bank could be a different scenario.

Buying Opportunities Emerge

For investors eyeing the S&P 500’s potential to climb higher, especially after its robust start to the year, this could be a buying opportunity. Ken Mahoney, CEO of Mahoney Asset Management, believes investors can re-enter megacap tech stocks, including Tesla, after their recent declines.

Upcoming Earnings and Economic Indicators

Next week will also feature a slew of consumer earnings reports and economic indicators:

  1. Tuesday, May 14: Home Depot, Charles Schwab earnings
  2. Wednesday, May 15: CPI, retail sales, employment data
  3. Thursday, May 16: Walmart, Deere earnings
  4. Friday, May 17: Non-farm payrolls, manufacturing data