For nearly two years now, the Federal Reserve has faced the challenge of taming inflation without creating a painful recession. It is an extremely difficult balancing act, and the Fed has seldom been successful in managing it in the past.
Despite the toughness of the challenge, the stock market has been growing optimistic that Fed Chair Jerome Powell and his crew may be able to manage it this time. Inflationary pressures have been falling so quickly that there is now more than an even chance that the central bank is done with interest-rate hikes.
Not only is the market optimistic about inflation, there is a growing belief that a recession can be avoided and that there will be a soft economic landing. Economists are optimistic that the job market will soften but will stay strong enough to avoid any real pain for consumers.
However, the economic bears have little faith in the Fed's ability to thread the economic needle. They are looking for the lag effect of monetary policy to gain steam. In addition, they are already pointing out how excessive savings that were created during the Covid crisis are now nearly depleted. They see credit-card debt rising and cash flow tightening as student loan debt will now have to be repaid.
While the economic view in the U.S. continues to be quite optimistic, in Europe the word that keeps popping up is "stagflation." The economic slowing in Germany is significant, and there are still signs that inflation can flare up again. In China, the government is working hard to create stimulus, but it is having limited impact so far.
The U.S. will see the latest CPI report on Wednesday, and that will be followed by the Fed interest-rate decision next week. Expectations for inflation are optimistic, so any uptick in CPI will likely cause a strong reaction.
The growth issue is also seeing pressure as the market digests a poor quarterly report from Oracle (ORCL) and looks ahead to the Apple (AAPL) announcement of its next generation of iPhones. Technology stocks bounced on Monday, but they have been losing momentum for a couple of weeks now and will react to the CPI report.
Market participants are largely in a state of paralysis as they wait for some economic clarity. We won't get it Tuesday, but the news flow will be heating up, and a new market narrative will soon take hold.
