Inflation Report Will Test Fed’s Plans and Bull Market’s Steam

The S&P 500 notched its third-straight weekly gain Friday, lifting its year-to-date advance to more than 28%.

But the market’s sunny optimism, set against wintry December, will face a Game of Thrones-like test this Wednesday: An inflation report is coming. That could test the mettle of this year’s barnburner stock rally and the Federal Reserve’s plans for future rate cuts.

The Case is in the Details

Markets overwhelmingly expect a rate cut when Fed governors meet next week on December 17 and 18: Fed fund futures are pricing in an 86% chance of a 25 basis-point cut, according to CME FedWatch. But when the Fed entered rate-cutting mode, for the first time in four years, in September, the labor market was cooling and the stock market had experienced a selloff just weeks before. Those concerns are muted now.

The latest jobs report from the Labor Department, released Friday, showed the US economy added 227,000 jobs in November — well over economists’ projection of 200,000, and showing particular resilience after Hurricanes Helene and Milton. Payrolls in September and October were also revised up by 56,000. Meanwhile, consumer spending, a huge driver of market sentiment, has the holiday spirit: last week’s Cyber Monday saw a record $13.3 billion in sales, according to Adobe Analytics, days after preliminary figures indicated record spending on Black Friday. The National Retail Federation expects a record $902 per person spent this holiday season. 

Whether the Fed should issue another cut is in the details:

• While the economy added a decent chunk of jobs, a decrease in the labor force participation rate meant the unemployment rate ticked up slightly to 4.2% — which was expected. “The economy continues to produce a healthy amount of job and income gains, but a further increase in the unemployment rate tempers some of the shine in the labor market and gives the Fed what it needs to cut rates in December,” said Morgan Stanley Wealth Management chief economist Ellen Zentner.
• However, stocks are on an impressive run, with the S&P 500 trading at more than 22 times expected earnings for the next 12 months. That is the highest price-to-earnings ratio in over three years, according to LSEG Datastream. It might not be the best decision to cut rates when assets may be overvalued.

Inflated Risk: The consumer prices data due on Wednesday, if inflation readings come in above expectations, could prove an obstacle to the market’s seemingly unabated upward trend. But the slight unemployment uptick created what TD Securities strategist Molly McGown deemed a “higher bar” for a pause in rate cuts, meaning markets are likely to continue getting a boost from the Fed.