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A stock market rally to kick off 2023 will be put to the test this week when investors face a highly-awaited inflation reading and the start of fourth quarter earnings season, which will be led by big banks.

Thursday morning will bring December’s Consumer Price Index (CPI), a release likely to dictate bets on whether the Federal Reserve raises interest rates by 0,25 percent or 0,50 percent at the start of next month.

Economists expect headline CPI rose 6,6 percent over the prior year in December, a downshift from the 7,1 percent increase seen in November, according to data from Bloomberg. On a month-over-month basis, CPI likely stayed flat.

Core CPI, which removes the volatile food and energy components of the report and is closely tracked by the Fed, is also expected to have risen at a slower pace last month, coming in at 5,7 percent after a 6 percent increase in November. Over the prior month, core CPI is expected to rise 0,3 percent after a 0,2 percent jump in November.

Policymakers monitor “core” inflation more closely due to its nuanced look at key inputs like housing, while the headline CPI figure has moved largely in tandem with volatile energy prices this year.

JPMorgan (JPM), the largest consumer bank in the US, will also deliver quarterly financial results along with industry peers Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC) on Friday morning as fourth quarter earnings season gets underway.

Wall Street’s banking giants — which have warned about the state of the economy, seen tremendous drop-offs in dealmaking revenues, and even begun trimming their workforces — are expected to offer the Street disappointing results.

Another “encouraging” jobs report

On Friday, US stocks soared after the latest monthly jobs report showed nonfarm payrolls rose by 223,000 in December as the unemployment rate dropped to 3.5 percent.

While these figures suggest an imbalance between labour supply and demand is still at hand, investors celebrated cooling wage growth as a sign the Fed may scale back its rate-hiking ambitions.

For the week, the S&P 500 and Dow Jones Industrial Average each gained roughly 1,5 percent while the technology-heavy Nasdaq Composite rose 1 percent. All three major averages surged more than 2 percent Friday.

“This is an encouraging jobs report for the Fed that shows the narrow path to a soft landing remains a possibility with wages cooling without requiring widespread job destruction,” Josh Jamner, investment strategy analyst at ClearBridge Investments said in a note Friday. “This print on its own doesn’t clearly support a 25- or a 50-basis-point hike at the next Fed meeting in February, and as a result, Thursday’s CPI release could prove crucial for that decision.”

The Federal Open Market Committee (FOMC), the group of Fed officials that vote on policy changes, is set to convene January 31-February 1 and deliver the first rate increase of 2023 and eighth of the current hiking cycle. Last month, the Fed raised interest rates by 50 basis points, bringing total increases to its benchmark policy rate to 4.25 percent in 2022.

Alexandra Wilson-Elizondo, head of multi-asset retail investing at Goldman Sachs Asset Management, said Friday’s jobs report adds to a series of economic releases that continue to place equal odds of a 25- or 50-basis-point rate increase at the next meeting. In other words, uncertainty remains.

“The [December jobs] report will most likely add to the growing narrative of a disinflationary environment crossing with a robust economy, and therefore a soft landing,” Wilson-Elizondo said in emailed comments. “This could prove positive for stocks in the short-term; however, our positioning remains risk-off into 2023.”

Wilson-Elizondo added: “It’s hard to see how risky assets can compete with approximately 5% yields in money market funds until more clarity is delivered on the inflation and growth mix. We expect the Fed to remain restrictive until there is clear evidence that tightness in the labor market is consistently improving.”

Bank earnings lead the way

JPMorgan, Citigroup, Bank of America, and Wells Fargo, along with asset management conglomerate BlackRock (BLK), are all set to report results in a flurry before the market open on Friday.

Banks typically benefit from central bank policy tightening, with higher interest rates boosting their net interest income — or the spread between a bank’s earnings on lending activities and interest it pays to depositors — and net interest margins. However, challenging market conditions that have dealt a blow to dealmaking, a primary profit driver, are poised to offset other aspects of their business.

“We are not likely to see any traction in investment banking, as equity and debt underwriting, as well as merger and acquisition markets, are expected to have disappointing performance,” Kenneth Leon, research director at CFRA Research, said in a note.

Leon also warned of “significant declines” in equity underwriting, including IPOs. According to a report on the IPO market last month from EY, 2022 saw just 1,333 initial public offerings worldwide based on data through Dec. 14, with these debuts raising a total of $179.5 billion — a 45% drop in listings raising and 61 percent fewer dollars raised compared to 2021.

Another notable component of bank earnings will be any insights credit card balances and savings accounts offer on the health of U.S. consumers.

Data last week from JPMorgan Asset Management, the bank’s investment management arm, estimated “excess savings” for U.S. households now stand at US$900 billion, down from a peak of US$2,1 trillion in early 2021 and roughly US$1,9 trillion at the beginning of last year. The drop shows inflation has effectively wiped out half of the savings Americans have accumulated since the pandemic began.

Even JPMorgan chief executive Jamie Dimon warned in a recent interview that inflation may tip the U.S. economy into recession this year.

“Inflation is eroding everything I just said,” Dimon noted, referring to consumer balance sheets that for now have held up, “and that trillion and a half dollars will run out sometime midyear next year.”–Yahoo Finance