U.S. equity markets have shifted into a holding pattern with a second consecutive week of slight losses following the sharp rally since the end of October in which the S&P 500 surged over 21%. Last week’s hotter-than-expected consumer and producer inflation reports threw more cold water on near-term rate cut expectations ahead of this week’s Federal Reserve meeting. Market participants are once again assessing the potential for rates to be held higher for longer if the final mile in the inflation fight isn’t as smooth and swift as anticipated coming into this year. For the week, the S&P 500 and Nasdaq Composite edged lower by 0.1% and 0.7%, while the Dow Jones was flat. Meanwhile, long-term interest rates jumped with the 10-year U.S. Treasury climbing to 4.31% from 4.08% in the week prior.

While inflation has fallen materially from the 2022 peak, February’s consumer and producer inflation readings (CPI and PPI) showed that progress has stalled out a bit recently with the trend in core CPI flattening out above 3% as pockets of stubborn price pressures remain. CPI increased 3.2% year-over-year and core CPI (excluding food and energy) grew 3.8%, which was down from 3.9% in January but higher than economists’ consensus forecast of 3.7%. Housing costs remain a major sticking point underpinning stubborn inflation. Energy and goods prices also ticked up last month after a stretch of negative monthly price growth that was supporting the falling trend in inflation overall.

Back-to-back upside surprises in inflation in January and February have ruled out any possibility of an initial rate cut at this week’s Fed meeting. While no cut is anticipated, market participants will be closely monitoring for any clues that Chairman Powell and the updated FOMC dot plot may offer as to when the first rate cut could come. Several Fed members have recently indicated that a long series of cuts may no longer be deemed necessary as broad economic strength has continued to surprise to the upside with only small pockets showing any signs of yielding to higher rates. The Fed’s dot plot—which show all of the voting committee members’ expectations for growth, inflation, and the policy rate over the coming years—is expected to still imply three rate cuts in 2024, but we may see rate expectations revised higher for 2025 and 2026.

Rising interest rates can pose a headwind to stocks as bond yields offer a more enticing investment alternative and a higher discount rate reduces the present value of future earnings. However, rising rates have done little to slow the recent rally in U.S. stocks like they did in 2022. The sustained strength of the economy in the face of higher rates and falling inflation has boosted investor confidence that corporate profit gains can continue, unlike in 2022 when many investors were concerned of an impending recession from restrictive policy.

Enthusiasm around the potential of developments in artificial intelligence are also stoking the rally, which may continue this week with Nvidia’s widely anticipated annual GPU Technology Conference (GTC). However, investors will be keen to start seeing the tangible impacts from AI gains on corporate earnings results this year (outside of just semiconductor companies and infrastructure providers). Corporate earnings will need to surpass a high bar this year and next (S&P 500 earnings expected to grow 11% and 13% in 2024 and 2025 after growing less than 2% last year) to justify lofty current stock valuations.