US Inflation Data to Set Market Tone Amid Stagflation Concerns

Following a weak jobs report in early August, investor focus now shifts to crucial US inflation data. The market will be closely watching the Consumer Price Index (CPI) data, scheduled for release on Tuesday, seeking evidence of trade tariffs pushing up prices. Kevin Gordon, senior investment strategist at Charles Schwab, stated that there are growing concerns about a potential "stagflationary trend," a scenario where inflation rises concurrently with unemployment. He indicated that any unexpected surge in inflation could "pour cold water on the market," causing US stocks to retreat from their recent rebound.

Impact of Weak Employment Data and Trade Tariffs

The disappointing July jobs report raised questions about the strength of the US economy, especially with the potential for trade tariffs to exacerbate inflationary pressures. The Federal Reserve is closely monitoring these developments as it seeks to achieve its dual mandate of full employment and price stability. Gordon explained that if CPI data indicates persistent high inflation, the Federal Reserve will find itself in a "trickier situation," especially since the market is currently pricing in a rate cut in September due to a cooling labor market.

The Federal Reserve's Stance and Rate Cut Prospects

Federal Reserve Chairman Jerome Powell has indicated that the impact of trade tariffs on inflation may be temporary, but cautioned about the potential for a more lasting effect. According to the CME FedWatch Tool, markets are currently pricing in a high probability of a 25 basis point rate cut in September, with further cuts expected before year-end.

Return of "Animal Spirits" to Markets

Alexis Deladerrière, co-chief investment officer of fundamental equities at Goldman Sachs Asset Management, believes that strong corporate earnings, significant corporate investments, and anticipated interest rate cuts are all positive factors for the economy and the stock market. He believes we are seeing a return of "animal spirits" to the markets, citing increased merger and acquisition activity and a rise in initial public offering (IPO) volume.

The Impact of Trade Tariffs on Inflation

The full impact of trade tariffs on inflation remains uncertain, as they have only recently been implemented. The impact depends partly on whether companies choose to absorb the tariff costs themselves or pass them on to consumers. Companies may also choose to move some of their production to the US to reduce costs.

Producer Price Index and Inflation Dynamics

In addition to the CPI, investors will also be watching the Producer Price Index (PPI) data, scheduled for release on Thursday. George Catrambone, head of Americas fixed income at DWS, stated that there are already initial signs that tariffs have raised prices on some goods in the US, including toys, furniture, and sporting goods.

Potential Stagflation and the Federal Reserve's Response

Despite signs of slowing US economic growth, Catrambone believes that a sustained period of "stagflation" is unlikely, even if inflation accelerates in the short term. He explained that if tariffs cause inflation problems, the Federal Reserve may maintain restrictive interest rates, while a weaker labor market would cool demand and help bring prices down.

Underweighting US, Overweighting International Markets

Jitania Kandhari, deputy chief investment officer of solutions and multi-asset at Morgan Stanley Investment Management, indicated that she has been "underweighting US assets and overweighting international markets" while monitoring inflation and economic growth data. She explained that she is not "completely bearish on the US market, because corporate earnings performance is still good," but there is likely to be a slowdown in the second half of the year, while other areas of the world (such as Europe) are more attractive due to fiscal and monetary policies.