Key Points
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Despite the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite launching to new highs in 2026, inflation has become a serious issue for the stock market.
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According to the Cleveland Fed’s Inflation Nowcasting tool, the Consumer Price Index (CPI) and Core Personal Consumption Expenditures (PCE) are heading in the wrong direction for October.
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The odds of multiple Federal Open Market Committee (FOMC) rate hikes are climbing.
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Year four of Wall Street’s bull market didn’t disappoint. The artificial intelligence (AI) infrastructure build-out lifted the Dow Jones Industrial Average (DJINDICES:^DJI), S&P 500 (SNPINDEX:^GSPC), and Nasdaq Composite (NASDAQINDEX:^IXIC) to several record highs throughout 2026.
But expecting the Dow, S&P 500, and Nasdaq Composite to head higher amid persistently elevated inflation is a tall task. Fed Chair Kevin Warsh and the Federal Open Market Committee (FOMC) have quite the challenge on their hands in delivering price stability. Unfortunately, the latest inflation update for October hasn’t done policymakers or Wall Street any favors.
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Fed Chair Kevin Warsh and the FOMC may raise rates multiple times in 2027. Image source: Official Federal Reserve Photo.
The Fed’s October inflation update is a double whammy for stocks
Though there’s no perfect inflation prediction tool, the Federal Reserve Bank of Cleveland’s Inflation Nowcasting tool comes pretty close. The Cleveland Fed’s tool provides daily forecasts for current- and forward-month inflation that are updated after the release of relevant economic data.
As of Oct. 20, forecasts for two key inflation measures were headed in the wrong direction.
For starters, we know the Consumer Price Index (CPI) reaccelerated to an annualized 3.7% in September. The Cleveland Fed’s inflation tool predicts further acceleration to 3.77% in October. Rapidly rising fuel costs, caused by the ongoing closure of the Strait of Hormuz, likely explain why headline inflation is heading higher.
What’s arguably even more worrisome is the projection for Core Personal Consumption Expenditures (PCE). Core PCE excludes volatile food and energy costs, providing a comprehensive look at long-term price trends.
After three consecutive months of Core PCE standing pat at 3%, the Inflation Nowcasting tool predicts a steady reacceleration to 3.05% in September (Core PCE for September will be released on the 30th) and 3.13% in October.
The projected uptick in Core PCE suggests that the U.S. economy is dealing with more than just an energy supply shock. Businesses altering their shipping routes and shifting suppliers due to the Iran war are just some of the added costs now affecting the broader economy.
Image source: Getty Images.
The odds of multiple FOMC rate hikes are climbing, and that’s terrible news for stocks
With headline inflation topping the Fed’s long-term 2% target for 67 months (and counting), Fed Chair Warsh hasn’t minced his words about delivering price stability. On Sept. 16, Warsh and 11 other FOMC members voted unanimously to raise interest rates by a quarter point to 3.75%-4.00%.
With both headline inflation and Core PCE, the latter of which is one of the Fed’s preferred price gauges, continuing to move in the wrong direction, the odds are increasing that policymakers will undertake several rate hikes over the next year.
According to the CME Group‘s (NASDAQ:CME) proprietary FedWatch Tool, which uses 30-day Fed Funds futures to track the probability of changes to the federal funds target rate, there’s a 72% probability that interest rates will rise by at least 75 basis points to 4.50%-4.75% by Sept. 15, 2027.
An aggressive Fed rate-hiking cycle would be awful news for a historically expensive, AI-driven bull market. If borrowing becomes costlier and the AI infrastructure build-out slows, even slightly, this could be enough of a catalyst to send a pricey stock market lower rather quickly.
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CME Group. The Motley Fool has a disclosure policy.
