Why Friday Is Make or Break for the Stock Market

*The inflation data are likely to be closely watched as an indicator of whether the Federal Reserve will cut interest rates this month, Above, Federal Reserve Chair Jerome Powell. (Justin Sullivan/Getty Images)

The stock market isn’t really doing much of anything right now. Friday will set its true direction.

The S&P 500 peaked at 6890 in late October, dropped 5% to 6538 a month later, and was just shy of its record on Tuesday. Two issues are behind the swings.

Investors are concerned that Big Tech companies are overspending on data centers to power their artificial-intelligence capabilities. At the same time, the economy is a worry. The government shutdown has left the market without critical economic data, making it even less clear than it would have been otherwise how rapidly the Federal Reserve will cut interest rates to prop up growth, which has slowed while inflation remains above the bank‘s target.

Now, the market is stuck bouncing around within that range. When stock prices rise toward the high, sellers come in to knock them lower because of the concerns. When prices fall too low, buyers come in to boost them, given how a dovish Fed could raise expectations for corporate earnings and the possibility that Big Tech will earn better-than-expected returns on its investments.

Much of that could change on Friday.

That is when the personal consumption expenditures price index will hit the wires for the first time since late September. That data showed the PCE, the Fed’s preferred measure of inflation, rose 2.7% year over year in August.

Since then, investors have mostly had to rely on guess work for where inflation is. Friday’s data will begin to clear away the fog.

Currently, economists expect 2.8%. While that would be far above the Fed’s 2% goal, investors know that companies are still passing along price increases as a result of tariffs. They may see a 2.8% increase as a signal that the Fed is likely to cut rates because policymakers have indicated that they would like to lower borrowing costs if they can. Anything below would be even better.

A lower PCE could bring interest rates down in the bond market and send stocks up. Right now, the federal-funds rate futures market is reflecting an 87% probability of a December rate cut, according to CME Group. If Friday’s data show cooling inflation, the probability would move closer to 100% and stocks would rise.

If the likelihood of a cut drops, stocks would drop. Data from RBC strategists led by Lori Calvasina show that since the middle of 2020, the S&P 500 has risen when investors expect more rate cuts, and vice versa.

That means Friday is a make-or-break day for the market. Select stocks have even more at stake.

Stocks that are most sensitive to changes in interest rates will likely make large moves. Look at the iShares U.S. Home Construction exchange-traded fund. It dropped 20% from a multi-month high of $117 in September to a low of $93 in November. Since then, it has rallied back to $103, smack in the middle of its range, as the probability of rate cuts has increased.

Housing demand relies on lower rates. If PCE comes in too hot, sending rates higher, the ETF will likely drop. A more benign result could send the ETF back toward its September high.

Elsewhere, chip stocks could make large moves. The VanEck Semiconductor ETF, home to Nvidia and other major AI chip makers, dropped 12% from its October record of $368 to a bottom of $325 in November. It is now up to $354.

While chip stocks have always tended to be more volatile than the broader market, their links to the artificial-intelligence trade create more scope for big moves. Lower rates would mean the large software and internet companies can more easily continue to invest in data centers—and chips—because some of that spending is now funded by debt. Higher rates make it more difficult for those companies to continue to increase their investments.

Expect big moves in all of these stocks on Friday. Trading until then just doesn’t matter much.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com