The Federal Reserve’s upcoming decision on interest rates takes center stage, with a key inflation report looming. As of midday Friday, Fed fund futures showed a 90% chance of a 25-basis-point rate cut, according to CME FedWatch.
This inflation data could test the ongoing U.S. stock rally. The S&P 500, poised for its third straight weekly gain, has surged over 27% this year. Expectations of further Fed rate cuts, coupled with economic resilience, have fueled optimism for equities.
Market Sentiment Faces a Test
Historically, strong equity gains occur when interest rates fall and the economy stays robust. Friday’s employment report supported this outlook, showing stronger-than-expected job growth but no dramatic labor market shifts. However, inflation data due Wednesday could disrupt the upbeat mood if it surpasses expectations.
“If inflation comes in hot, it could challenge the stock market,” said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management. Such uncertainty could weigh on markets ahead of the Federal Reserve’s December 17–18 meeting.
The November payroll report strengthened bets on a rate cut, revealing a gain of 227,000 jobs but an uptick in unemployment to 4.2%. Fed fund futures trading reflects near-certainty of a rate cut, but the consumer price index (CPI) could influence this trajectory.
Inflation’s Role in Rate Decisions
Economists expect CPI to rise 2.7% year-over-year through November, Reuters reports. A higher-than-expected figure might lead the Fed to signal fewer rate cuts in 2025, according to Miskin. Tariffs and other inflationary pressures could also shape decisions.
Molly McGown, U.S. rates strategist at TD Securities, noted a “higher bar” for the CPI report to derail plans for a December rate cut. She predicts the Fed may pause cuts in early 2024, awaiting clarity on President-elect Donald Trump’s fiscal policies.
“Once Fed Chair Jerome Powell has more policy details, the central bank will adjust its monetary framework,” McGown added.
Stock Valuations and Risks
Meanwhile, the stock market’s momentum raises concerns. The S&P 500’s price-to-earnings ratio has reached 22.6, its highest in over three years, according to LSEG Datastream.
Yardeni Research highlighted bearish signals from contrarian indicators, including high bullish sentiment among advisors and foreign purchases of U.S. equities.
Despite these warnings, some investors remain optimistic. The year-end period is seasonally strong for stocks, keeping hopes alive for further gains in the weeks ahead.
