Why Tomorrow Is an Important Day for the Stock Market

Investors have been waiting all year long for the Federal Reserve to pause its aggressive campaign of hiking interest rates. While the Fed has slowed, it hasn’t yet stopped, despite the fact that a banking crisis broke out in March.

After the March jobs report Friday, which came in around expectations, investors seem to think that another quarter-point hike is likely in store for the Fed’s May meeting. Now, the only likely way the Fed may pause in May is if key inflation data that’s due out tomorrow comes in favorably. That’s why tomorrow is an important day for the stock market.

The Fed needs supporting data

In 2022, some of the highest inflation in more than 40 years struck the economy. The Fed found itself behind the eight ball and began hiking interest rates quickly. Rising interest rates tend to make riskier assets like stocks less appealing, especially on the growth side, because they reduce the future value of cash flow and make safer assets yield more. The benchmark S&P 500 index fell roughly 20% last year.

Person looking at multiple computer monitors.

Image source: Getty Images.

This year, the S&P 500 has gotten off to a strong start and is up about 7.3% year to date — mostly because traders have been expecting the Fed to end its rate-hiking campaign, and maybe even cut interest rates as well. But the Fed needs to see the data to show that it has won its war with inflation. That includes cracks in the historically strong labor market, which the Fed believes is contributing to inflation, as well as slowing consumer prices.

After a hot start to the year, in which the U.S. economy added more than 800,000 jobs in January and February, hiring slowed in March; in line with estimates, only 236,000 jobs were added, for the weakest month of hiring since December 2020. Additionally, average hourly earnings rose 0.3% in March and the unemployment rate fell slightly to 3.5%.

The March jobs report wasn’t bad news; it’s heading in the right direction. But following the report, traders increased their bets that the Fed would hike rates by a quarter-point in May, bring the Fed’s benchmark lending rate inside a range of 5% to 5.25%.

Interestingly, though, Dow futures jumped higher immediately following the jobs report. While a healthy labor market has lately been a problem for the stock market, investors have also been concerned about a more severe recession: The recent banking crisis is expected to lead banks to tighten credit, which could have a chilling effect on the economy.

Tomorrow, the March reading for the Consumer Price Index (CPI) will be released at 8:30 a.m. The CPI, which tracks the prices on a market basket of consumer goods and services, is a key gauge of inflation. For February’s report, the CPI rose 0.4% on a monthly basis and was up 6% year over year. That’s certainly progress, but the Fed’s inflation target is 2%, and there are still items within the CPI like shelter costs that have shown no signs of slowing down.

What the Fed would need to see

The Federal Reserve Bank of Cleveland’s Nowcasting service is projecting that the CPI will have risen 0.5% on a monthly basis in March, and will be up about 5.3% year over year.

I think for the Fed to not raise rates in May, it would have to see the April CPI numbers come in meaningfully below the estimates, showing that inflation is slowing more than expected. But I wouldn’t recommend trying to trade on this update tomorrow, because data showing inflation rapidly slowing could get investors worried about a deeper-than-expected recession.

Either way, tomorrow will certainly be an important day: It’s likely to determine what the Federal Reserve does at its May meeting, which will have a major impact on the stock market one way or another.