The defining moment for the stock market comes with the CPI, the Fed's decision

(Bloomberg) — This is the week everyone has been waiting for. With the release of a key inflation measure, the Federal Reserve’s interest rate decision and comments from Chairman Jerome Powell in the aftermath, investors hope to finally have a clear picture of what lies ahead for the battered stock market and economy in 2023.

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But after a tumultuous year that saw the S&P 500 post its biggest annual loss since 2008, stock traders are bracing for one sure thing in the coming sessions: more volatility.

Inflation reports have rattled stocks all year, leaving markets to assess the central bank’s likely policy path amid relentlessly rising prices. This week’s CPI reading is crucial as signs of easing inflation could lift stocks later in the year, dampening expectations for further Fed hikes.

Over the past six months, the S&P 500 has seen an average move of about 3% in either direction on the day the CPI is released, according to data compiled by Bloomberg. This is the highest level since 2009. The S&P 500 has fallen on seven of the 11 CPI reporting days this year.

The US central bank is expected to hike by half a point at the end of its meeting on December 14. So equity investors are more focused on what Powell has to say at his press conference afterward, looking for any hints on the forward path for interest rates. The Fed’s forecast for the US economy will also be a focus, along with any changes in central bankers’ interest rate forecasts.

Read more: Fed’s peak interest rates seen dashing Wall Street hopes for 2023 cuts

Of course, global money managers are hoping 2022 ends well after the S&P 500 posted two consecutive monthly gains for the first time in more than a year in October and November. But betting on where things will play out in the coming months, as the S&P 500 stares into its first year of decline since 2018, is especially challenging.

“Getting the right position is extremely difficult for investors right now,” said Eric Ristuben, chief investment strategist at Russell Investments. “Fed policy is really holding back the stock market party until Wall Street is convinced the central bank is close to ending rate hikes.”

The lack of investor conviction in this key week is evident in the options markets. The Cboe Volatility Index, or VIX, was down on 80% of the days over the past 10 weeks ending Dec. 2. That has happened only three other times since the so-called Wall Street Fear Gauge began, data compiled by Bespoke Investment Group show.

“It feels like the VIX has fallen too much given the big events like the CPI data and the interest rate decision next week,” said Brent Kochuba, founder of analytics service SpotGamma. “People are starting to recognize the fact that maybe things have gotten too complacent.”

Meanwhile, demand to hedge against losses in individual stocks pushed the Cboe stock’s put-to-call ratio to 1.5 on Wednesday, the highest level since 2001 and more than twice the average this year.

Futures market pricing shows the Fed’s key interest rate peaking at around 4.9% in the first half of 2023. That means there is still room for the Fed to raise rates while taming stubbornly high rates. Over the past eight rate hike cycles, the Fed has continued to raise borrowing costs until they have topped the CPI, according to Carson Investment Research.

A half-point hike on December 14 would leave the fed funds rate in the 4.25%-4.5% range. Meanwhile, Tuesday’s CPI report is expected to show the index eased to a 7.3 percent annual increase in November from 7.7 percent the previous month. But nothing is guaranteed. Stocks faltered on Friday after a hotter-than-expected output prices report.

“It’s definitely a tough time for investors,” said Stephanie Lang, chief investment officer at Homrich Berg, whose firm recommends being positioned defensively in favor of consumer staples and healthcare companies. “If history is any indication of the results of Fed overreach, it makes us cautious about stocks.”

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