By Jacob Sonenshine

Stocks jumped after this week's inflation data. The problem is that there's not a lot to love in the numbers.

The S&P 500 gained 2.9% this week to about 6000, while the Nasdaq Composite rose 2.5% and the Dow Jones Industrial Average advanced 3.4%. It was a relief rally; much of the gains came on Wednesday with the S&P 500 entering the day down 4% from its record closing high of 6090 in late December. Wednesday's inflation data then came to the rescue, sending stocks higher.

The consumer price index rose 2.9% year over year in December, in line with forecasts, but above November's 2.7%. Core CPI, which strips out volatile food and energy prices, gained 3.2%, a tick below forecasts and under November's 3.3%. At the very least, the data were not much worse than what some traders had feared.

The reality is that inflation remains well above the Federal Reserve's 2% goal. The average headline CPI has been 2.7% in the past three months, above the 2.6% average for the three months that ended in September. So the trend of inflation, when considering a larger sample size of results, is inching higher, not lower. To be sure, the Fed's preferred inflation metric, the personal consumption index, has been running a few tenths of a percentage point below headline CPI. But PCE, too, has trended upwards in the past few months and remains above 2%.

The result is that the Fed is unlikely to reduce interest rates aggressively. The federal-funds futures market now expects just one interest-rate cut this year, according to data from CME Group, leaving it above 4%. The possibility of a rate hike remains on the table, especially given the incoming Trump administration's various inflationary policy proposals, including aggressive tariffs.

Fed policy uncertainty explains why some expect stock and bond prices to experience volatility. Bond yields won't drop much as long as there's a strong possibility of elevated inflation and interest rates. "Markets are likely to be whipsawed over the next few data releases as investors seek a narrative that they can be comfortable with for more than just a few days at a time," writes Seema Shah, chief global strategist at Principal Asset Management.

To that point, the 10-year Treasury yield may remain elevated. It's currently at 4.61%, and while it fell back this past week, it's still above the key 4.5% level, where sellers have come in to bring bond prices lower and yields higher in the past month. Sellers could easily keep it above that level, given the state of inflation and the fed-funds rate,

dragging the S&P 500 lower, and, with some delay, slowing the economy and corporate earnings growth. Lower earnings than expected and elevated bond yields make bonds a more appealing option, limiting the extent to which investors bid stocks upward. Right now, analysts expect aggregate 2025 earnings for S&P 500 companies to yield an investor 4.7%, given the S&P's current level, so there's essentially no additional expected return versus bonds to compensate investors for taking the risk of owning stocks.

The relatively poor yield for stocks versus bonds is starting to look "troublesome," writes Lori Calvasina, chief U.S. equity strategist at RBC.

That's partly why the S&P 500 stopped rising after Wednesday, and failed to reach its record high. Instead, it fell on Thursday, then rose on Friday, but less so than Wednesday. Any disappointing commentary from the Fed could trigger another wave of selling.

"At these levels, vulnerability just continues to increase," Shah says.

Buyer beware.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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January 17, 2025 12:08 ET (17:08 GMT)

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