Stock market faces crucial test this week: 3 questions to decide rally’s fate

Was January’s jobs number a ‘fluke’?

On the economic data front, the most important question that investors will be looking to answer is whether January’s huge job gains continued in February. The U.S. economy added 517,000 jobs in January, according to the Labor Department, far outstripping expectations and setting in motion a market rethink on just how high the Federal Reserve will take interest rates in its effort to bring down inflation.

Since then, weekly jobless benefit claims have continued to show few Americans filing for unemployment benefits, fueling expectations that another blockbuster gain in jobs could be due in the data for February next Friday, which in turn could force the Federal Reserve to resort to even more aggressive interest rate hikes, according to Steve Sosnick, chief strategist at Interactive Brokers, during a phone call with MarketWatch.

“Will it turn out that the number we got last month was a fluke? Or is this part of a new trend?,” Sosnick said.

Read: Warm weather means stock-market investors shouldn’t look for a cooler February jobs report: economist

What will Powell say?

Investors haven’t heard from Powell since he participated in a Q&A at the Economic Club of Washington on Feb. 7.

During his back-and-forth with private-equity billionaire David Rubenstein, Powell reiterated that signs of disinflation are emerging, although he acknowledged the journey back to the Fed’s 2% target would likely be “bumpy.”

Since then, a run of hotter-than-expected inflation reports showed that a streak of waning price pressures might be coming to an end.

The cost of living rose 0.5% in January, the biggest increase in three months, according to the consumer-price index released Feb. 14. The annual rate of inflation, meanwhile, slowed again to 6.4% from 6.5%, but economists had expected an even larger decline. The January producer-price index and the core personal consumption expenditure index, the Fed’s favored inflation measure, also came in hotter than expected.

As a result, investors will be listening closely to Powell to see what the Fed chair has to say about the central bank’s efforts to crush inflation when he heads to Capitol Hill on Tuesday for testimony before the Senate Banking Committee, followed by testimony before the House Financial Services Committee a day later.

“If the Fed truly is data dependent, the latest inflation data hasn’t been at all what the Fed wants to see. So how will Powell dance around that?” Sosnick told MarketWatch, in a phone interview.

Check out: Powell to talk to Congress about the possibility of more interest-rate hikes, not fewer

How will stocks respond to higher yields?

On top of the economic data and commentary from Powell, investors will also be watching to see how higher bond yields will impact equities.

The fact that investors can now earn a yield north of 5% by simply buying six-month Treasury bills means stocks are now facing major competition from a far less risky asset class, according to Callie Cox, U.S. investment analyst at eToro.

What’s more, many on Wall Street expect bond yields to continue to climb, potentially adding to the pressure facing U.S. equity benchmarks like the S&P 500 index
SPX,
+1.61%,
Nasdaq Composite
COMP,
+1.97%
and Dow Jones Industrial Average
DJIA,
+1.17%.

“We expect the adjustment in rates is not over,” according to a team of economists at Mizuho Securities.

See: Inflation data pushed the 10-year Treasury yield above 4%. How much higher can interest rates go?

Uncertainty abounds

Investors started the year with expectations that the Fed could cut interest rates as soon as this fall. However, hotter-than-expected economic data and warnings about more rate hikes from Fed officials have since tempered that view.

To wit, moves in Fed funds futures suggest investors see a much lower likelihood of rate cuts later this year, according to the CME’s FedWatch tool. while the fed-funds rate is seen peaking well above 5%.

It remains to be seen exactly how far the Fed will hike interest rates. Some are betting that the central bank could eventually raise its policy rate as high as 6%, or perhaps even higher, according to Mohannad Aama, a portfolio manager at Beam Capital.

“There’s still so much uncertainty,” Aama said.

Because of this, every data point could potentially influence investors’ expectations about how far rates will rise, potentially delivering a hit, or boost, to stocks, he said.

U.S. stocks suffered in February, with major indexes losing ground and denting an early 2023 rally. However, stocks bounced last week, however, with the Dow snapping a run of four straight weekly losses and the S&P 500 breaking a three-week streak.

The Dow rose 1.8% last week, while the S&P 500 advanced 1.9% and the Nasdaq Composite added 2%.