The stock market faces a crucial test this week: 3 questions to determine the fate of the rally

There will be no rest this week for investors awaiting a major report on the state of the US job market, along with the biennial congressional testimony from Federal Reserve Chairman Jerome Powell.

To complicate matters, investors will also be watching to see how stocks react to more attractive risk-free yields in the bond market after the 10-year Treasury yield temporarily crossed the 4% threshold last week, and many expect it to rise even further.

Was the January jobs issue a fluke?

In terms of economic data, the main question investors will want to answer is whether the massive job gains seen in January continued into February. According to the Labor Department, the US economy added 517,000 jobs in January, far exceeding expectations and prompting the market to rethink how much the Federal Reserve will raise interest rates in its bid to curb inflation.

Since then, few Americans are still filing for unemployment benefits, fueling expectations that another blockbuster gain in jobs could follow in February data next Friday, which in turn could force the Federal Reserve to resort to to even more aggressive rate hikes, according to Steve Sosnick, chief strategist at Interactive Brokers, during a phone call with MarketWatch.

“Will it turn out that the number we got last month was a fluke? Or is this part of a new trend?” Sosnick said.

Read: Warm weather means stock market investors shouldn’t look for a cooler February jobs report: Economist

What will Powell say?

Investors have not heard from Powell since he took part in a Q&A at the Economic Club of Washington on Feb. 7.

During his back-and-forth conversation with private equity billionaire David Rubenstein, Powell reiterated that signs of disinflation were emerging, though he acknowledged that the journey back to the Fed’s 2% target would likely be “bumpy.”

Since then, a series of higher-than-expected inflation reports showed that a series of easing price pressures could be coming to an end.

The cost of living rose 0.5% in January, the biggest increase in three months, according to the Consumer Price Index released Feb. 14. an even greater decline. January’s producer price index and the core personal consumption expenditure index, the Fed’s preferred inflation measure, also came out hotter than expected.

As a result, investors will listen closely to Powell to see what the Fed chairman has to say about the central bank’s efforts to quell inflation when he heads to Capitol Hill on Tuesday for testimony before the Senate Banking Committee, followed by by testimony before the House of Representatives. Financial Services Committee a day later.

“If the Fed really depends on data, then the latest inflation data is not at all what the Fed wants to see. So how will Powell dance around that? Sosnick told MarketWatch in a phone interview.

Checking out: Powell to talk to Congress about the possibility of more rate hikes, not less

How will stocks react to higher yields?

In addition to the economic data and Powell’s commentary, investors will also be on the lookout for how higher bond yields will affect stocks.

The fact that investors can now earn returns of more than 5% simply by buying six-month Treasury bills means that equities now face stiff competition from a much less risky asset class, said Callie Cox, US investment analyst at eToro.

In addition, many on Wall Street expect bond yields to continue rising, potentially adding to the pressure facing US stock benchmarks such as the S&P 500 index.

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Nasdaq composite

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“We don’t expect the rate adjustment to be over,” said a team of economists at Mizuho Securities.

To see: Inflation data pushed 10-year Treasury rates above 4%. How much higher can interest rates go?

Uncertainty is everywhere

Investors started the year expecting the Fed to cut interest rates this fall. But better-than-expected economic data and warnings of more rate hikes from Fed officials have since tempered that view.

Indeed, according to the CME’s FedWatch tool, movements in Fed Funds futures suggest that investors see a much smaller chance of rate cuts later this year. while the fed-funds rate peaks well above 5%.

It remains to be seen exactly how far the Fed will raise interest rates. Some are betting that the central bank may eventually raise its policy rate to 6%, or perhaps even higher, according to Mohannad Aama, a portfolio manager at Beam Capital.

“There’s still so much uncertainty,” Aama said.

Because of this, each data point could potentially influence investors’ expectations of how far interest rates will rise, potentially delivering a hit or boost to stocks, he said.

US equities struggled in February, with major indices losing ground and denting a rally into early 2023. However, stocks rebounded last week, with the Dow posting a run of four straight weekly losses and the S&P 500 breaking a three-week streak.

The Dow was up 1.8% last week, while the S&P 500 was up 1.9% and the Nasdaq Composite up 2%.

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