Inflation numbers, midterms loom as U.S. stocks struggle By Reuters

© Reuters. FILE: A Wall Street sign outside the New York Stock Exchange in New York City, New York, U.S., October 2, 2020. REUTERS/Carlo Allegri

by David Randall

NEW YORK (Reuters) – A buoyant rally in U.S. stocks is facing a double dose of potentially market-shattering events next week: the U.S. midterm elections and inflation data that could weigh on the Federal Reserve’s monetary policy.

A rally on Wall Street on Friday dispelled some of the gloom since the Federal Reserve raised interest rates on Wednesday, but Chairman Jerome Powell said policymakers were likely to take rates higher than expected in their bid to curb inflation.

Nevertheless, the week ended with a 4.6% loss, likely burning off many bulls who had jumped aboard the October rally that lifted the index more than 8% from its lows. Breakdown of the index in Oct. A low of 12 would mark the fifth time this year that stocks have risen 6% or more only to reverse course and make fresh lows.

GRAPHIC: False starts

Meanwhile, data from BoFA Global Research showed about $62.1 billion in cash flows last week, the biggest inflow since the COVID-19 crash in early 2020, underscoring the pessimism that has prevailed among many market participants.

“We think we’re headed for a rocky landing for the economy, and next week we’re going to get two pretty big indicators of what that’s going to look like,” said Steve Chiavraone, head of multi-asset solutions at larger-allocation Federated Hermes ( NYSE: in cash and commodities than usual.

Consumer price data has fueled big market moves this year, as rising inflation forced investors to raise expectations for Fed rate hikes. Stronger than expected reading for Nov. 10 would likely strengthen the case for the Fed to proceed.

Investors are now pricing in a 5.1% peak for central bank interest rates next year, compared with expectations of just under 5% before the Fed’s last meeting. The central bank has raised the policy rate to 3.75% this year.

“If we get a lower inflation reading, you could get some relief based on that data,” said Emily Roland, chief investment adviser at John Hancock Investment Management. In that case, however, markets will focus more on the higher probability of a recession.”

Strategists at Wells Fargo (NYSE: ) believes the CPI is more likely to come in below expectations. They see the central bank’s final interest rate falling by 12 basis points or more if the consumer price index comes in at a monthly increase of less than 0.4%. Analysts polled by Reuters expect a 0.5% monthly increase.

“All told, inflationary forces are gathering momentum,” Sarah House, senior economist at the firm, wrote on Friday.

Meanwhile, analysts said Democrats had a surprise victory in November. 8. Midterm elections, which will determine the leadership of Congress, could fuel concerns about higher fiscal spending and inflation.

Republicans have been leading in polls and betting markets, and many analysts believe the result is likely to be a split government, with the GOP controlling the House and possibly the Senate in the second half of Democratic President Joe Biden’s term.

“If the Dems were to retain full control of Congress, then fiscal spending is more likely to go up, and that would be very problematic in this inflationary environment,” said Spencer Lerner, portfolio manager at Harbor Capital.

Options hedges on the S&P 500 indicate a nearly 3% move in either direction the day after the election, analysts at Goldman Sachs (NYSE: ) wrote this week, nearly double the average daily move the index has recorded this year.

Some investors are more optimistic about a period of stronger markets brought on by past midterm elections than about moves stemming from the vote itself: The S&P 500 has posted positive returns in the 12 months following all 19 midterm elections since World War II, according to CFRA Research.

Similar gains could be in store this time around — as long as inflation numbers aren’t higher than investors expect, said Kei Sasaki, chief portfolio adviser at Northern Trust (NASDAQ: ), which believes energy and financial stocks will do well in a divided government.

“The interim results will give more visibility and help drive investor confidence more,” he said.

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