Stock market’s defining moment arrives with CPI, Fed decision

It’s the week everyone’s been waiting for. With the release a key measure of inflation, the Federal Reserve interest-rate decision and Chair Jerome Powell’s comments afterward, investors are hoping to finally have a clear view of what’s ahead for a beaten-down stock market and economy in 2023.

But after a tumultuous year that has the S&P 500 Index looking at its biggest annual loss since 2008, equity traders are prepared for one sure thing over the coming sessions: more volatility.

Inflation reports have been rocking equities all year, leaving markets to gauge the central bank’s likely policy path amid relentlessly surging prices. This week’s consumer price index reading is crucial, as signs of ebbing inflation could buoy shares into year-end by tempering expectations for further Fed hikes.

Over the past six months, the S&P 500 has seen an average move of about 3% in either direction on the day CPI has been released, according to data compiled by Bloomberg. That’s the highest since 2009. The S&P 500 has fallen on seven of the 11 CPI reporting days this year.

The US central bank is widely expected to deliver a half-point hike at the close of its meeting on Dec. 14. So equity investors are more focused on what Powell has to say at his press conference afterward, looking for any hints on the path forward for interest rates. The Fed’s outlook for the US economy will also be a focus, along with any changes in central bankers’ rate projections.

Of course, global money managers are hoping 2022 will end on a high note after the S&P 500 posted two consecutive monthly advances for the first time in more than a year in October and November. But, betting on where things go in the coming months with the S&P 500 staring at its first down year since 2018 is particularly challenging.

“Getting the right position is extraordinarily difficult for investors right now,” said Erik Ristuben, chief investment strategist at Russell Investments. “Fed policy is really putting a damper on the stock-market party until Wall Street is confident that the central bank is close to being done with raising rates.”

Investors’ lack of conviction heading into this key week is apparent in the options markets. The Cboe Volatility Index, or VIX, has declined on 80% of the days over the past 10 weeks ending Dec. 2. That has only happened three other times since the inception of Wall Street’s so-called fear gauge, data compiled by Bespoke Investment Group show.

“There’s this sense that the VIX has dropped too much, considering the big events like the CPI data and the interest-rate decision next week,” said Brent Kochuba, founder of analytic service SpotGamma. “People are starting to wake up to the fact that maybe things have become a bit too complacent.”

Meanwhile, demand for hedges against single-stock losses pushed the Cboe equity put-to-call ratio to 1.5 on Wednesday — the highest level since 2001 and more than double this year’s average.

Pricing in the futures market shows the Fed’s policy rate peaking at around 4.9% in the first half of 2023. That means there’s still room for the Fed to lift rates as it tames stubbornly high prices. In the past eight rate-hiking cycles, the Fed continued to lift borrowing costs until they were above CPI, according to Carson Investment Research.

A half-point hike on Dec. 14 would leave the fed funds rate in a range of 4.25%-4.5%. Meanwhile, Tuesday’s CPI report is expected to show the index eased to a 7.3% annual increase in November, from 7.7% the month before. But nothing is assured. Stocks wobbled on Friday after a hotter-than-expected report on producer prices.

“It’s definitely a tricky time for investors,” said Stephanie Lang, chief investment officer at Homrich Berg, whose firm recommends being defensively positioned in favor of consumer staples and health-care companies. “If history is any indication of the Fed’s track record of overshooting, that makes us cautious on equities.”