Markets are pricing in a strong chance of another Federal Reserve rate increase in September, but Barclays says two upcoming data releases could still change that outlook.
According to strategist Emmanuel Cau, today’s US payrolls report and next week’s CPI inflation data are the most important near-term catalysts for stocks and interest rate expectations.
Payrolls and CPI Could Shift Fed Expectations
Cau said a meaningful downside surprise in either report could force investors to rethink the current outlook for monetary policy.
Barclays economists now expect the Federal Reserve to raise interest rates two more times this year, with increases projected for September and December.
That forecast is broadly in line with current market expectations.
However, Barclays does not view another rate hike as guaranteed.
Cau noted that a significant amount of hawkishness is already priced into markets, especially as parts of the US economy are beginning to show signs of slower activity.
Softer Jobs Data Could Help Rate-Sensitive Stocks
A weaker payrolls report could provide short-term relief for sectors that are especially sensitive to interest rates.
Utilities and real estate are among the areas that could benefit if investors reduce expectations for further Fed tightening.
Higher interest rates typically increase borrowing costs and can weigh heavily on sectors that depend on financing or offer bond-like income.
A softer labor market report could therefore support rate-sensitive stocks, even if Barclays continues to expect additional Fed hikes later this year.
Hawkish Fed Expectations Have Already Increased
The recent shift toward higher rate expectations has partly been driven by comments from Fed Chair Kevin Warsh at Jackson Hole.
Those remarks contributed to a more hawkish market view and pushed investors to price in a greater chance of another rate increase.
However, upcoming economic data could determine whether that outlook remains intact.
Payrolls and inflation will therefore be closely watched for signs that the US economy is slowing or that price pressures are beginning to ease.
Oil Prices Add to Inflation Risks
Rising oil prices are making the inflation outlook more complicated.
Crude prices have climbed during the continuing US-Iran standoff, adding pressure on central banks.
Higher energy costs can feed directly into inflation and make it harder for policymakers to justify keeping interest rates unchanged.
The impact is not limited to the United States.
European policymakers are also facing renewed energy-related inflation risks.
ECB Faces Similar Policy Challenge
Cau noted that European gas prices have risen to their highest levels since early 2023.
However, prices remain well below the extreme levels seen during the 2022 energy crisis following Russia’s invasion of Ukraine.
The European Central Bank is also expected to raise rates again this month.
However, the risks could increase if energy prices remain elevated and concerns about stagflation continue to grow.
Stagflation combines weak economic growth with high inflation, creating a particularly difficult environment for both central banks and financial markets.
European Stocks Could Face Stagflation Pressure
A stagflation scenario could place additional pressure on European equity markets.
Consumer-focused companies could be especially vulnerable because they are already dealing with slower economic growth and higher costs.
Higher interest rates and elevated energy prices could also reduce household spending and corporate investment.
That combination could create a more challenging outlook for European stocks.
Stocks Are Becoming More Sensitive to Rates
Barclays believes the market environment is beginning to change.
Strong second-quarter earnings helped support stocks earlier in the summer and reduced the impact of tighter financial conditions.
However, that earnings boost is now fading.
Cau said stocks have become increasingly sensitive to movements in interest rates and oil prices.
Macroeconomic factors are once again becoming the main drivers of equity markets.
Autumn Could Bring More Market Volatility
Barclays expects a busy calendar of potential market-moving events during the autumn.
These include central bank decisions, geopolitical developments and expected talks between Chinese President Xi Jinping and US President Donald Trump.
With so many potential catalysts, equity markets could experience higher volatility in the coming months.
Investors may therefore place greater importance on economic data and central bank signals than they did during the recent earnings season.
Barclays Recommends a More Defensive Approach
Given the increased uncertainty, Barclays favors a more defensive short-term strategy.
Cau said investors may want to hedge portfolios and reduce some exposure to high-beta assets.
That could involve trimming riskier cyclical stocks while using hedging strategies to protect against larger market swings.
However, Barclays is not making an outright bearish call on equities.
The firm still sees a supportive outlook into the end of the year, provided that interest rates and oil prices begin to stabilize.
For now, payrolls and CPI remain two of the most important indicators for determining whether stocks can withstand renewed pressure from interest rates.
