A hot inflation report this week could upset the stock market's relief rally, even after a strong jobs reported quelled recession fears, Barclays says

• The rally in US stocks could lose its footing if the July inflation report unexpectedly shows prices accelerating, Barclays said.
• The July jobs blowout delivered last week underlined persistent inflation pressures, suggesting the Fed will remain aggressive with rate hikes.

US stocks have stepped higher in recent weeks, slicing down bear-market losses, but that momentum could hit a wall if this week's inflation report unexpectedly spikes up, according to Barclays.

On Wednesday, the Bureau of Labor Statistics will release the consumer price index for July, and its arrival became even more anticipated following last week's blowout payrolls report. The US economy added 528,000 jobs last month, more than double than expected and putting into question fears about a recession.

"Last week's robust US employment report underlined persistent inflation pressures. That implies a need for higher rates from the [Federal Reserve], regardless of softer commodities or slowing growth," said Barclays in its Macro House View Weekly research note published Monday. It foresees upside risk to its forecast for the Fed to raise its key interest rate by 50 basis points at its September 20-21 meeting.

"An upside [inflation] surprise could upset the recent relief rally, while challenging the recent softness of the US Dollar," said Barclays. It noted the US Dollar Index has dropped more than 2% from this year's peak in mid-July as a decline in Treasury yields and re-pricing of the Fed's peak interest rate has supported risk sentiment.

Financial markets recently started to fixate on expectations that growth and inflation will decline over the next two to six quarters, allowing central banks to turn more dovish on monetary policy, analysts noted.

Hopes for a potentially dovish Fed pivot fueled the 9.1% surge in the S&P 500 in July, and the index tacked another 0.4% during the first week of August. The moves have helped cut down its 2022 loss to 13% after it was dumped into a bear market this year.

"But a succession of [Federal Reserve] members said last week that they are determined to boost the funds rate to a restrictive position as quickly as possible in order to rein in inflation and restore price stability," Barclays UK said in a note led by Ben McLannahan at the bank's product management group.

Barclays expects the month-over-month reading of consumer prices to fade to 0.6% in July from 0.7% in June and the annual rate to slow to 8.9%.

Headline inflation shot up to 9.1% in June, the fastest inflation reading since November 1981, paced by food and energy increases. Core CPI, which strips out food and energy prices, had risen 5.9%.

The US Dollar Index on Monday was down 0.4% at 106.23, and the S&P 500 rose by nearly 1% during the session to 4,179.

"The market continues to expect central banks to turn dovish as growth weakens. But the easing in financial conditions is not compatible with the need to control inflation," said Barclays FX strategist Juan Prada in a separate note published Sunday.