The rally in US stocks, which came despite uncertainty on Wall Street, is set to be tested this week, with key inflation data threatening to shut the door on expectations that the Federal Reserve will pull back from its hawkish policy.

The S&P index faced tough challenges this summer and has rallied 13% from its mid-June lows as Wall Street hopes rate hikes will end earlier than expected.

Friday’s US jobs report bolstered the case for the increase, but weighed little on stocks as the index fell less than 0.2% on the day, snapping its third straight week of gains.

Stocks could face further upside if investors believe the central bank is winning its battle against rising consumer prices, but recent commodity prices and signs that inflation remains strong despite an easing of monetary tightening could further weigh on the outlook. Interest rate hikes will likely stop early next year, and that could lead to the destruction of risk appetite, pushing stocks back down.

“We’re now at a point where consumer price data is reaching its critical mass, which gives us some indication of what we and the central bank are facing,” said Michael Antonelli, Baird’s managing director of market strategy.

lame walk

The recovery was short-lived in the middle of the 2022 bear market, and three benchmarks reflected the S&P index reaching new lows, raising doubts about the sustainability of the recent rally. The bleak outlook for investors was highlighted by the latest data from Bank of America’s global research arm, which saw the average recommended stock allocation by US strategists, on the sell side, fall to its lowest level in more than five years in July, according to the S&P. 500 rose 9.1% in the month, its biggest gain since November 2020.

Stock trading by institutional investors is also subdued, and the level of holdings for preferred and regular investors is at the 12th percentile of its range since January 2010, according to a Deutsche Bank report published last week. Federal Reserve officials last week said they were puzzled by bond market prices reflecting investors’ expectations that the central bank will start cutting interest rates in the first half of next year, as San Francisco Fed President Mary Daley said.

U.S. interest rate futures posted a 69% chance of a 75 basis point hike at the September meeting, up from about 41% ahead of the payrolls data, and futures traders were also taking into account a fed funds rate of 3.57% by the end of the year. Options markets offer little evidence of investors rushing to capitalize on the stock market.

Trade alert data showed the average one-month daily volume in US-listed put options fell 3% on June 16.

Matthew Timm, head of traded equity derivatives at Cantor Fitzgerald, expressed surprise: “We were surprised to see investors fearing poor market performance and chasing bullish buying. People are watching.

Corporate profits

Celia Rodgers Hobbs, portfolio manager at Brandwine Global, believes much of the recent rally has been driven by short-covering, particularly in several high-performing tech names that have underperformed this year. “The market doesn’t want to miss the next rally, but it’s hard to know if it will last or not,” he said.

Of course, investors aren’t destined to pull back en masse. Corporate earnings were stronger than expected in the second quarter, with 77.5% of S&P companies beating earnings estimates from Refinitiv data; That lifted some of Wall Street’s gains.

Also, Bird’s Antonelli believes the lower-than-expected inflation numbers next week could push more investors into the stock market.

Tom Siomets, chief investment officer at AE Wealth Management, said the market has yet to bottom, urging investors to avoid chasing stocks. “The market is creating some wishful thinking, and investors are ignoring the old adage: Don’t fight the Fed,” he says.

Weekly calendar

Monday

11:00 New York Federal Reserve Inflation Forecast 3 years

tuesday

6:00 National Federation of Independent Small Business Index

8:30 Industrial Production Report and Labor Cost Report

Wednesday

8:30 CBI

10:00 Total Trade Inventories Report

14:00 Union Budget Statement compared to previous year

Thursday

8:30 Benefit Claims

8:30 p.m

Friday

8:30 Import Price Index

10:00 Yumich Consumer Price Index Report

10:00 Yumić 5-year inflation expectations report