Wall St Week: The U.S. stock markets rebound is subject to a key inflation test

The rally that saved U.S. stocks from a bear market is up against serious challenges next week.

Wall St Week: The U.S. stock markets rebound is subject to a key inflation test

The rally that saved U.S. stocks from a bear market is up against serious challenges next week. Consumer price data will provide insight into how much the Federal Reserve must do to fight the worst inflation since decades.

Despite a rough week, the S&P 500 is up more than 5% over last month's lows. This saw the benchmark index drop to almost 20% from its record high. After losing 1% over the past week, the index fell 14% to its Jan. 3 record.

Investors' belief that policymakers are working to curb rising prices could have a greater upside. Inflation signs that are still strong could be a sign that more aggressive monetary tightening is needed. This could potentially scare a market that has been hampered by fears that a Fed that is too hawkish might cause a severe blow to U.S. economic growth.

"This market will likely remain range-bound until there is a meaningful movement lower in inflation," Mona Mahajan, senior financial strategist at Edward Jones said. Large-cap stocks are currently preferred over small-cap stocks due to the ability of larger companies to absorb more input and wage costs. "Clearly, the print will be crucial next week."

The consumer price index (CPI), which rose 8.3% in April from the 8.5% annual rate in April, was the largest year-on–year increase in 40 years. Friday's May inflation report is one of the final key data pieces before the Fed's June 14-15 meeting. At which time the central bank is widely expected increase rates by 50 basis points.

Paul Nolte, portfolio manger at Kingsview Investment Management, stated that if inflation "continues to be a problem", the Fed may not be able to coast later in the year. He added, "The higher interest rates, the greater the struggle for market."

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