Inflation takes over as the next big focus for markets after July's monster jobs report

Published Fri, Aug 5 20223:23 PM EDTUpdated Fri, Aug 5 20224:06 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Investors switch their focus to inflation in the week ahead, after July's strong jobs report signaled the Federal Reserve may need to take an even tougher stance with interest rate hikes. It could also be a week in which investors watch to see if rising Treasury yields start to slow the technology sector's summer rally. The surprise 528,000 increase in July payrolls announced Friday challenged the market view that economic weakness may force the Fed to pare back its rate hikes or even pause by the spring of next year. Stocks sold off Friday after the employment report, and Treasury yields shot higher. Futures markets immediately priced in a higher, 0.75 percentage point hike for September, on top of the Fed's two 75 basis point interest rate increases in June and July. The market had been expecting a half-point hike next month. (One basis point equals 0.01 of a percentage point.) "We get a lot of inflation data next week in terms of inflation expectations, CPI, PPI, unit labor costs. I think that will be the story of the week," said Michael Arone, chief investment strategist at State Street Global Advisors. "As the labor market continues to show strength, it will be important for investors to see if inflation has peaked and rolls over. If it hasn't and continues to accelerate, expect some volatility." The consumer price index is reported Wednesday, while the producer price index — a measure of wholesale prices — is due Thursday. Headline CPI, which includes energy and food, rose at a sizzling pace of 9.1% in June , compared to a year ago. That figure is anticipated to be lower for July, at 8.7%, according to Dow Jones. But core CPI, excluding energy and food, is expected to rise to 6.1% year-over-year, from a pace of 5.9% in June. Consumer sentiment is released Friday, and it contains consumer inflation expectations, which are closely watched by the Fed. The evolving path for rate hikes The Fed has already raised its target rate range to 2.25% to 2.50%. The central bank's last forecast shows the Fed expects that rate could be 3.25% to 3.50% by the end of the year. That could change if the data remains hot. The central bank could introduce a higher interest rate forecast in September. "What's going to happen is that the Fed's neutral rate, the one that is neither restrictive nor accommodative, continues to be a moving target," said Arone. "I think what investors do with this is they continue to try to find out what that level is... You contrast two GDP figures that showed a technical recession in terms of a negative first and second quarter, and you contrast this in terms of the labor market. It's a very complex environment to determine what that neutral environment is going to be… and it's constantly changing." Fed Chairman Jerome Powell said after the last rate hike that the central bank was probably close to the neutral rate. That comment helped spur some investors to believe that the Fed could even cut rates next year. "There was a bit of wishful thinking that the Fed was about to end rate hiking and we're going to be like 2018, and growth stocks would be the story again" said Richard Bernstein, chief investment officer of Richard Bernstein Advisors. "I think the mistake here is to go into long-duration growth stocks. I think that's the mistake." Bernstein said he likes defensive and cyclical names for now. Tech shares are considered long-duration growth stocks. When interest rates move higher, those shares are vulnerable. They are high-priced based on the potential for their future earnings. "If CPI is hotter again, I think that will really put a thorn in the side of the growth stock story," said Bernstein. "The growth stock story is precipitated on slow nominal growth, going back to the sub-5% we saw for so many years." Bonds on a roller-coaster ride Stocks in the past week turned in a mixed performance, with the Nasdaq Composite ending the week up 2.2%. The Nasdaq rose on the back of tech, the best performing sector for the week. The S & P 500 was up 0.3% for the week, while the Dow Jones Industrial Average was slightly lower, down 0.1%. Bond yields have been on a wild ride at the same time. The benchmark 10-year yield was as high as 2.86% on Friday, but it hit a low just above 2.51% earlier in the week. At the time, bond strategists said it is likely the market put in a near-term bottom for the yield at that level. Strategists also question whether a new period of rising yields could threaten the tech rally, particularly if the next batch of inflation data is hot. "We've suggested that people think of the market as a seesaw, and the story continues to be which side of the seesaw that you're on," said Bernstein. "There's the growth stock side, and then there's everything else in the world." The earnings season is still underway, but the flow of reports have slowed down. Walt Disney reports Wednesday afternoon, and there are a number of travel-related companies, like Norwegian Cruise Lines, Marriott Vacations , Wynn Resorts , and Hilton Grand Vacations. Week ahead calendar Monday Earnings: AIG, Take-Two Interactive, SoftBank, Elanco Animal Health , 3D Systems, Clovis Oncology, Palantir Technologies, Barrick Gold, Viatris, Tegna , BioNTech, Marriott Vacations, ACCO Brands, International Flavors and Fragrances, Cabot, Groupon, Mesa Air, Ambac Financial, Tyson Foods, Party City , ONEOK Tuesday Earnings : Capri Holdings, Aramark, Coinbase, Wynn Resorts, Akamai, Axion, Rackspace, Hyatt Hotels, H & R Block, Trivago, Bausch Health, Aramark, Dine Brands, Ralph Lauren, Norwegian Cruise Line, Sysco, Planet Fitness, Hilton Grand Vacations, Reynolds Consumer Products 6:00 a.m. NFIB small business survey 8:30 a.m. Productivity and costs Wednesday Earnings: Walt Disney , Fox Corp, Honda Motor, Wendy's, Bumble, Jack in the Box, Vacasa, Vizio, CyberArk Software 8:30 a.m. CPI 10:00 a.m. Wholesale trade 11:00 a.m. Chicago Fed President Charles Evans 2:00 p.m. Federal budget 2:00 p.m. Minneapolis Fed President Neel Kashkari Thursday Earnings: Siemens, Cardinal Health, Hanesbrands, Canada Goose, US Foods, Warby Parker, Brookfield Asset Management, Illumina, Rivian, Poshmark 8:30 a.m. Initial claims 8:30 a.m. PPI Friday 8:30 a.m. Import prices 10:00 a.m. Consumer sentiment