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Stock investors are a bit on edge ahead of upcoming critical inflation data and the start of Q3 earnings season.
Fed pivot
Bulls are hoping the Producer Price Index on Wednesday and Consumer Price Index on Thursday will confirm their belief that inflation has “peaked” which in turn could spark another rally as investors return to bet on the Fed backing off its tightening program.
A so-called “Fed pivot” has been anticipated and rallied upon multiple times this year already, only to be dashed by continued strong inflationary data and tough talk from Fed officials.
Economists say that interest rate hikes can take 6 months or more to filter through the economy and impact inflation, so the worry remains that the Fed goes too far, too fast and ends up “breaking” something.
Warnings about a potential recession continue to circulate with JPMorgan CEO Jamie Dimon the latest to forecast a recession in 2023 that could be compounded by the Fed's aggressive rate hikes and Russia's war in Ukraine. Of course Russia's war has roiled energy, grain, and other commodity markets, which in turn have kept upward pressure on inflation.
Food supplies
Keep in mind, global food supplies have even bigger problems than just Russia and Ukraine, with severe droughts and extreme flooding taking a toll on nearly every continent.
The Fed has no ability to control commodity supplies or prices but they also can't keep lifting rates indefinitely. Due to the dysfunction already witnessed in some financial markets as well as signs that the US economy is slowing down, many bulls still believe the Fed will, at the very least, go for smaller rate hikes starting in November or December.
Money supply
For those that believe inflation is more of a money supply problem – aka due to a massive increase in the amount of money in the financial system – it's worth noting that the Fed stopped contributing to that in March when it made its final asset purchases as part of “quantitative easing.” The central bank is now essentially removing money from the system via “quantitative tightening” as it allows mature bonds to roll off its balance sheet.
Additionally, you could count the Fed's rate increases, which also began in March, as a money supply-reducer as it hinders borrowing.
Economists also say it takes around 6 to 18 months for reductions in the money supply to impact inflation. However, it is still not clear what the Fed would consider a “clear sign” that inflation is on the retreat.
Data to watch
Investors hope the “minutes” from the Fed's last meeting, which are due out on Wednesday, might provide some additional clues on that front.
Today, investors won't really get any new data to chew on besides the NFIB Small Business Optimism Index.
There also aren't any notable US earnings on tap, although investors are growing a bit more nervous that the forward guidance could further dampen the outlook for the quarters ahead, especially as the US dollar remains stubbornly strong. That in turn could burst the bulls' hopes to regain lost ground off the back of better-than-expected Q3 results.
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