Earnings season teams up with CPI! Can the US stock market recover its upward momentum this week?

The US stock market will usher in a new round of earnings season this week, with banks such as JPMorgan (JPM.US), Wells Fargo (WFC.US), Bank of America (BAC.US), BlackRock (BLK.US), and Citigroup (C.US) releasing their earnings reports one after another. This also marks the beginning of the fourth quarter earnings season for the major Wall Street banks. At the same time, this week will also see the release of heavyweight inflation data - the US Consumer Price Index (CPI) and Producer Price Index (PPI) for December.

The US stock market entered the fourth quarter earnings season with caution. After nine consecutive weeks of gains, the S&P 500 index saw a weekly decline at the beginning of 2024. In the past five trading days, the tech-heavy Invesco QQQ Trust fell nearly 4%. The S&P 500 index fell nearly 2%, and the Dow Jones Industrial Average fell nearly 1%.

CPI data expected to rise slightly

The unexpectedly strong December non-farm payroll report showed that the foundation of the US labor market remained solid as of 2023. In December of last year, the US job market added 216,000 jobs, an increase of about 40,000 from the previous month, far exceeding Wall Street's expectations. The unemployment rate remained stable at 3.7%, the lowest level in history. Average hourly earnings, an inflation indicator closely watched and a measure of the balance of workers in the labor market, grew by 0.4% MoM and 4.1% YoY, compared to economists' expectations of 0.3% MoM and 3.9% YoY.

Thomas Simons, an economist at Jefferies, wrote in a report to clients last Friday: "Strong wage data suggests that the Federal Reserve will keep interest rates unchanged for a longer period of time. In the past few months, wage growth has far outpaced inflation. The Fed is pleased with the progress they have made in bringing the inflation rate down to 2%, but the continued strength in wages will make it more difficult to solve the 'last mile' problem."

Contrary to Simons' agreement, the debate over when the Federal Reserve will cut interest rates continues to brew. Goldman Sachs still believes that the first rate cut will take place in March. Jan Hatzius, the chief economist of Goldman Sachs, wrote last Friday: "Against the backdrop of declining core inflation, we still expect the Federal Reserve to cut interest rates by 25 basis points in March, May, and June consecutively."Currently, the market pricing is leaning towards Goldman Sachs, but the possibilities are changing. According to CME's FedWatch tool, as of last Friday afternoon, the market estimated a 66% chance of a Fed rate cut in March, compared to nearly 88% a week ago.

The debate over when the Fed will cut rates mainly revolves around how confident the Fed is in achieving its 2% inflation target. Wall Street economists expect overall inflation to rise 3.2% in December, slightly higher than November's 3.1%. Prices are expected to rise 0.2% MoM, slightly higher than November's 0.1%. Excluding food and energy prices, the "core" CPI is expected to rise 3.8% YoY in December, slowing down from November's 4.0% increase. The monthly core price increase is expected to be 0.3%.

In a research report last Friday, the Bank of America Merrill Lynch economic team wrote: "Overall, we expect next week's CPI report to show continued slowing inflation, which will prompt the Federal Open Market Committee (FOMC) to start cutting rates in June. Energy prices were more stable last month and are unlikely to repeat the sharp declines seen in October and November. We expect the disinflationary trend in core goods to continue against the backdrop of normalization in demand, a healthier supply chain, and a decline in commodity prices from their peak."

Earnings season sheds light on consumer spending

On the corporate front, the fourth-quarter earnings season will kick off with heavyweight companies. Delta Air Lines (DAL.US), JPMorgan Chase, Citigroup, Bank of America, and BlackRock will all release their earnings reports on Friday morning.

Investors will be watching for the latest data on consumer spending and the performance of financial companies in a rising interest rate environment. Mike Mayo, a financial analyst at Bank of America, said the prospect of a Fed rate cut in 2024 could boost bank stocks. Mayo said, "You can see that with the Fed's policy shift in December last year, bank stocks started to outperform the market. But when you actually see (the Fed rate cut) happen, I think the performance of banks will be even better. I think the downside risks to the economy will be mitigated."

The financial industry will be the first to reveal corporate performance in the fourth quarter. Overall, Wall Street is becoming increasingly pessimistic about fourth-quarter earnings. According to FactSet data, since September 30, expected earnings for S&P 500 index constituents have declined by 6.8%. This is the largest decline since the third quarter of 2022, well above the 20-year average decline of 3.8%.Deutsche Bank's Chief US Equity Strategist, Binky Chadha, predicts that this quarter's earnings will be even stronger. However, Chadha believes that in the short term, this may not necessarily boost the market. He points out that the stock market has experienced a significant increase at the end of the year, putting it in an unstable position. In his report to clients, Chadha explains, "Historically, the magnitude of the stock market's rise during earnings season is mainly related to market performance and stock positions. Although we expect strong growth and strong performance this quarter, the market rebound may be influenced by the S&P 500 index's strong rise since the last earnings season and the increase in stock positions (but not to an extreme extent)."