The big inflation report in the week ahead could determine whether this market rally continues

Published Fri, Sep 9 20222:55 PM EDTUpdated Fri, Sep 9 20225:32 PM EDT

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

Stocks could continue their march higher at the start of the coming week, as investors await an important report Tuesday on consumer inflation. The consumer price index for August is one of a number of reports on a busy economic calendar in the week ahead, but it is the one final data points that market strategists expect could help determine how much the Federal Reserve raises interest rates on Sept. 21. Evercore ISI's Julian Emanuel said the market is bracing for a 75 basis point (or three-quarters) increase in the fed funds target rate from the Fed, which would be the third in a row of that size. "Even if the inflation data surprises to the upside, as long as it's not a material upside surprise, the market is likely to shrug that off," said Emanuel, head of equity, derivatives and quantitative strategy at Evercore. "If inflation data surprises to the downside, which we think it could, then any thoughts that 75 is not an absolutely signed, sealed and delivered deal are going to be extremely bullish for stocks." Stocks surged Friday and were higher for the week, breaking a three-week losing streak. The S & P 500 closed at 4,067, gaining 3.6% for the week. The index broke below 3,900 Tuesday, but reversed and increased back above that key level. "We think the price action this week, combined with the bearish sentiment and the prospect of the Fed potentially going on a no-promise pause in 2023 has put a floor under stocks here," said Emanuel. Emanuel's view contrasts with some strategists, who believe the market could return to its lows or even fall below them before the selling is over. For instance, Guggenheim's Scott Minerd told CNBC Thursday that the bear market is still intact, and the S & P 500 could decline 20% from here by mid-October. Minerd, Guggenheim's global chief investment officer, said it could be a buying opportunity if and when the S & P falls to 3,000 to 3,400. Minerd said the central bank may be leaning too far in the hawkish direction. "I think there is a thought or a fear at the Fed that if they abruptly end or pause that they're going to run the risk of blowing their credibility," he said. Fed officials have discouraged investors from the view that they will reverse course on rate hiking and start cutting rates by the second half of next year. They have instead pushed the idea that rates will remain higher for longer in order to combat inflation. Still hot inflation print Besides the CPI Tuesday morning, the producer price index inflation reading is due on Wednesday, while retail sales and industrial production reports are released Thursday. But CPI could be the key for the trading week. Rob Dent, U.S. senior economist at Nomura, expects core CPI was up 0.4% in August, or at a 6.1% annual pace, hotter than July's 5.9% increase. On headline inflation, the drop in gasoline prices is expected to pull that annual pace down to 8% from 8.5% in July, he added. "We think the big focus should be on month-over-month core inflation," he said. "It just feels like we're falling into a period of tug of war." He said while supply chain related prices, like used vehicles and apparel, should be falling, there will continue to be a pull higher in inflation from increases in rent-related components. Dent said the CPI report could be confusing, particularly since many people focus on the headline data, not the core, which excludes food and energy. "I think the broad message is inflation is still very, very high. The problem is it's shifting to the services side, which is being driven more by wage growth," said Dent. "In terms of our concerns about inflation, I don't think the August CPI report is going to make us or the Fed feel a whole lot better." Dent expects the Fed is ready to raise rates by another 75 basis points in September. A basis point equals 0.01 percentage point. "It seems like the August CPI will have more of an impact on the November FOMC meeting rather than September," Dent said. "It's coming out in the blackout period. They've seen enough to tell them another 75 is probably warranted ... . Everything we're seeing on wages, services inflation is telling you the inflation situation is still pretty dire ... . It just feels like the bar for forgoing a 75 basis point hike based on August CPI is very high. You'd have to see a decline in core inflation." Fed officials have been very hawkish in the past week. Fed Chair Jerome Powell on Thursday reinforced the Fed will keep rates high to combat inflation. Cleveland Fed President Loretta Mester on Wednesday said inflation remains very high and the fed funds rate could go "somewhat above" 4% by early next year. Fed officials will not be out speaking in the coming week because they will be in a blackout period ahead of their next two-day meeting, which begins on Sept. 20. For now, the futures market is pricing in an end, or terminal rate of just below 4% in the first quarter of next year. "Our expectation is by the year-end, we'll be at 3.75% to 4%," said Dent. He expects the Fed to reach a terminal rate of 4.125% by February. Interest rates and the U.S. dollar have been rising but took a reprieve at the end of the week. That helped reduce some of the pressure on stocks. Should expectations for the Fed rise on CPI, the pressure could return. Technically speaking Oppenheimer technical analyst Ari Wald said rising Treasury yields are a potentially big hazard for stocks, as the market traverses the typically rocky month of September into early October. The 10-year yield, which moves opposite price, was near 3.32% Friday, below its June high of 3.49%. "Long duration bond yields remain our top concern," said Wald. "That was clearly a driver of the weakness in the first half of the year, and we think that rates likely need to top if the equity market is going to bottom." But the stock market has also made positive strides this past week. "We are of the view [that] the market is in the process of bottoming. You want to be mindful about the seasonals. That's going to last for a few weeks," he said. September is the worst month for stock market performance, with the S & P 500 declining 0.6% on average since World War II, according to CFRA. One positive note in the past week: The S & P 500 rose back above its 50-day moving average. That level was at 4,030 Friday. The 50-day is simply the average of the past 50 closes, and a move above it that holds is considered a sign of positive momentum. Wald said the next challenge for the S & P 500 is to break back above its 200-day moving average, now at 4,275. "The 200-day average is going to be an important one on the upside that was rejected in mid-August," he said. "That's often viewed as the demarcation line between bull and bear markets." Wald said he expects the S & P to ultimately break back above it, and then rally in the fourth quarter. "Our expectation is the S & P can make it to 4,600," he said. Week ahead calendar Monday Earnings: Oracle , Rent the Runway Tuesday 6:00 a.m. NFIB small business survey 8:30 a.m. CPI 2:00 p.m. Federal budget Wednesday 8:30 a.m. PPI Thursday Earnings: Adobe 8:30 a.m. Initial claims 8:30 a.m. Retail sales 8:30 a.m. Import prices 8:30 a.m. Empire State manufacturing 8:30 a.m. Philadelphia Fed manufacturing 9:15 a.m. Industrial production 10:00 a.m. Business inventories Friday 8:30 a.m. Business leaders survey 10:00 a.m. Consumer sentient 4:00 p.m. TIC data