The Market Wants to Celebrate Slowing CPI, But the Fed Could Spoil the Party

Stocks continue to move higher as market players await the CPI report at 8.30 am ET. The S&P 500 jumped 1.4% on Monday and held above key support of over 3900.

Last month the S&P 500 rose around 5.5% on a softer-than-expected CPI report, but conditions this time are quite different. The market celebrated the idea of “peak inflation” last month, but the S&P 500 is now around the same level it was at the end of the day on the last CPI report.

Over this past month, the market narrative has shifted from concerns about consumer inflation. It has been more worried about how strong employment has been, and the potential for a recession as higher interest rates extract a toll.

A 0.5% interest rate hike at Wednesday’s Fed meeting has been anticipated ever since the last CPI report, and the market even had a short-lived bounce when Chair Jerome Powell hinted that was very likely.

If CPI does come in lighter than expected once again, can market players expect the same sort of euphoric response that occurred back on November 10? Probably not. A soft CPI is already expected to a great degree, and that is reflected in the 0.5% rate increase that should occur Wednesday. The primary economic issue remains the terminal rate — how high will rates go in the months ahead? Powell and the Fed are focused on labor costs more than anything else right now, and CPI isn’t going to change that.

One of the challenges that traders face is that even if the market does celebrate a soft CPI report Tuesday, they will immediately have to confront the Fed policy meeting Wednesday. It is highly unlikely that Powell is going to suggest that the battle against inflation is won. The Fed is going to remind the market that it has much more work to do and that a soft CPI report does not do that much to shift what it will need to do in the months ahead.

The primary market narrative has been shifting to worries about a recession early next year. The fact that interest rates have been coming down has more to do with fears of economic slowing rather than a celebration of lower inflation.

We have a very tricky trading environment. A soft CPI report is going to excite some market players, but then we have to worry about the Fed spoiling the party. If you want to navigate this market effectively, then stay fast and flexible.