Stock-market rebound to be tested by inflation reports as stagflation threat emerges

Yahoo

9 hours ago

Markets are facing a crucial reading on U.S. inflation in the coming week, soon after regaining their footing following volatility triggered by a weak jobs report at the start of August.
Investors will be watching closely for any evidence of prices rising in the economy due to tariffs, with data from the consumer-price index due out Tuesday. Some worry that a 'stagflationary trend' risks taking hold, which involves both inflation and the unemployment rate picking up, according to Kevin Gordon, senior investment strategist at Charles Schwab.
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Hotter-than-expected inflation could 'deliver a reality check to the market,' potentially causing stocks to stumble from their recent rebound in the U.S., Gordon said in a phone interview.
The technology-heavy Nasdaq Composite COMP closed Friday at a fresh record peak, while the S&P 500 SPX finished just shy of its all-time high, according to Dow Jones Market Data. That's after the S&P 500 saw on Aug. 1 its biggest drop since April, on a surprisingly soft U.S. employment report for July that included big revisions lower for jobs growth in previous months.
'The surprise nature of the July jobs report' puts more focus on the upcoming inflation print from the consumer-price index for that same month — particularly as concern about the potential for tariffs to increase already elevated inflation has kept the Federal Reserve from lowering interest rates, according to Gordon.
A hot inflation reading from the CPI data would put the Fed in a 'tougher spot,' at a time when the market is expecting rate cuts in September because of the softening labor market, he said.
The Fed, which is monitoring risks to its dual mandate of maximum employment and price stability, has an inflation target of 2%.
'Higher tariffs have begun to show through more clearly to prices of some goods, but their overall effects on economic activity and inflation remain to be seen,' Fed Chair Jerome Powell said in remarks at a press conference on July 30. 'A reasonable base case is that the effects on inflation could be short-lived—reflecting a one-time shift in the price level,' he said. 'But it is also possible that the inflationary effects could instead be more persistent.'
The federal-funds-futures market indicated on Friday an 89.1% chance that the Fed will cut its benchmark rate in September by a quarter percentage point from the current range of 4.25% to 4.5%, according to the CME FedWatch Tool. Traders were pricing in two or three rate cuts by year's end. At a bankers' conference in Colorado on Saturday, Fed governor Michelle Bowman heightened her push for cutting interest rates over the Federal Reserve's three remaining meetings this year.
Despite concerns over recent deterioration in the labor market, the unemployment rate remains historically low even with its slight increase in July to 4.2%, and the U.S. economy expanded in the second quarter.
Resilient corporate earnings, big investments announced by companies and expected rate cuts should all be helpful for the economy and equity market, said Alexis Deladerrière, co-deputy chief investment officer for the fundamental equity business at Goldman Sachs Asset Management, in a phone interview.
'We are beginning to see the return of animal spirits in the equity market,' he said, pointing to a pick up in mergers and acquisitions and increased volume in initial public offerings. The acceleration is M&A is 'a sign of confidence from business leaders' about their outlook, he said.
The U.S. stock market has roared back from its low in April, a trough hit after President Donald Trump announced his 'liberation day' tariffs. The tariffs had sparked confusion in markets as the large levies upended the system of global trade, raising questions about where they would settle after negotiations and what their impact may be on growth and inflation.
Read: Apple's stock gains as new announcement with Trump could help its tariff problem
But today there's more certainty around 'the new rules of the game,' said Deladerrière. 'We are now in a situation where not everything is clear, but enough is clear for businesses' to make decisions around hiring, investing and repositioning their supply chains to help protect their profit margins, he explained.
Still, the full impact of tariffs on inflation is too early to tell, as they've just started to be implemented, according to Deladerrière. Their effect will depend in part on whether companies decide to absorb the tariffs or pass them along to their customers; businesses may also choose to relocate some of their production to the U.S. to mitigate their cost, he said.
There are some early signs that tariffs are increasing prices in the U.S., including in areas such as toys and furniture and sporting goods, according to George Catrambone, head of fixed income for the Americas at DWS.
'That tick higher in inflation is coming from the goods side,' while inflation on the services side of the economy is much more 'subdued' after easing since the pandemic, he said. 'You have to look closer at the interplay between goods and services and then arrive at a more holistic picture as to whether or not disinflationary forces are in place, or we're going to reaccelerate because of the tariffs.'
Investors will also get reading on wholesale inflation in the U.S. in the upcoming week, with data from the producer-price index scheduled to be released on Thursday.
While there's signs that growth in the U.S. economy is slowing, Catrambone wouldn't expect to see' long-lasting' stagflation should inflation accelerate in the near-term.
Read: 'The stagflation theme in markets is intensifying': What investors need to know
'You may see it for a three-month period, six-month period max,' Catrambone said of stagflation. The Fed may keep rates restrictive if inflation were a problem due to tariffs, while a weakening labor market would help bring prices down as it would cool demand, he explained.
In the bond market, the yield on 10-year Treasury note BX:TMUBMUSD10Y ended Friday at 4.282%, not far above where it had landed after its steep drop on Aug. 1 — the day investors digested the July jobs report, according to Dow Jones Market Data.
As investors watch for data on inflation and economic growth, Jitania Kandhari, deputy CIO of solutions and multi-asset group at Morgan Stanley Investment Management, said by phone that she's been 'rebalancing out of the U.S. into international markets.'
Kandhari said that she's not 'outright bearish because earnings have kept up,' but that a slowdown may be ahead in the second half of the year while other parts of the world, like Europe, look compelling because of their fiscal and monetary policies. She described her overall portfolio as 'slightly underweight the U.S.'
The U.S. stock market closed higher Friday, with the Dow Jones Industrial Average DJIA, S&P 500 and Nasdaq Composite all booking weekly gains. That left the S&P 500 up 8.6% so far this year, according to FactSet data.
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