NEW YORK: A highly awaited inflation report and elevated bond yields offer the latest test to a US stock rally that has delivered hefty gains this year.

The benchmark S&P 500 index is up 16.6% year to date, fuelled by an improving economic outlook, excitement over developments in artificial intelligence and signs that the Federal Reserve (Fed) is close to ending its market-bruising US interest rate hikes.

Stocks’ near-term trajectory, however, may depend on whether this week’s inflation report shows consumer prices remaining subdued.

Investors are also closely watching the path of Treasury yields, which rattled equity markets in recent days by rising to fresh year highs.

The S&P 500 fell 2.27% this week, its biggest weekly decline since March 10.

“After a massive run-up in equities, any sort of blip in terms of any of the macro data (is) probably going to be a reason for people to take profits,” said Jack Janasiewicz, lead portfolio strategist and portfolio manager at Natixis Investment Managers.

While consumer prices have not been rising as fast lately, some investors worry stubborn inflation may force the Fed to leave rates at current levels longer than expected.

The US reports consumer price data on Aug 10.

Last Friday, US employment data showed the economy maintained a moderate pace of job growth. Yet, wages grew at a faster-than-expected annual clip of 4.4%.

Many fear that is too high to be consistent with the Fed’s 2% inflation target.

Janasiewicz of Natixis said a stronger-than-expected consumer price reading this week could spark a decline of up to 5% in the S&P 500. He said such a drop would be “healthy”, given the index’s big run-up this year.

Other investors have been taking profits. Concerns over rising stock valuations pushed Aaron Chan, a managing partner at equity hedge fund Recurve Capital, to trim stakes in shares of companies including Amazon.com, which is up 68% this year, and Norwegian Cruise Line, up 47%.

The S&P 500 is trading at about 19.5 times forward 12-month earnings estimates, much pricier than its long-term average of about 15.6 times, according to Refinitiv Datastream.

Rising global prices for oil and food, which the Fed’s rate increases do little to control, may have more sway on inflation in coming months, said Tim Murray, a capital markets strategist at T Rowe Price.

Prices for Brent crude were on track for their sixth straight week of gains, up roughly 17% in that period on signs of tightening global supply and rising demand.

“As long as the consumer price index remains flat to trending down, the market will accept it thoroughly,” said Ann Miletti, Allspring’s head of active equity.

“If we do see upticks, it is really dependent on where the upticks are and whether or not investors believe they’re temporary in nature.”

Miletti is growing more bullish on corners of the market that have underperformed, including small-cap stocks.

A stronger-than-expected inflation number this week could also boost Treasury yields further.

Yields, which move inversely to bond prices, spiked this week following a downgrade of the US credit rating by Fitch and on the prospect of a flood of Treasury supply in the third quarter. — Reuters