Will US Stagflation Risks Emerge? This Week's CPI Report to Test Stock Rally's Resilience

A fresh look at inflation trends will test the resilience of the U.S. stock market's rally in the coming week. Some investors say that after surging to record highs this summer, equities may be primed for a potential pullback.

The benchmark S&P 500 has risen more than 7% year-to-date and is just about 1% below its late-July record closing high. After briefly plunging on weak nonfarm payrolls data earlier this month, stocks rebounded sharply last week without sustained pressure.

However, Wall Street strategists—including those at Deutsche Bank and Morgan Stanley—have recently suggested that following nearly four months of uninterrupted gains, the market may be due for a correction. The rally has pushed U.S. stock valuations to historically expensive levels just as the historically riskier seasonal period for equities begins.

The U.S. July Consumer Price Index (CPI) report, due Tuesday, could trigger market volatility. If the data shows inflation running hotter than expected, it may dampen growing expectations for rate cuts.

Dominic Pappalardo, chief multi-asset strategist at Morningstar Wealth, said: "I do think the market is set up for a pullback. There are a lot of concerns simmering beneath the surface."

Since its April low, the S&P 500 has surged over 20% as investors’ fears of a tariff-induced recession eased. According to LSEG Datastream, the index now trades at 22.4 times its expected earnings for the next 12 months—well above its long-term average forward P/E of 15.8. This closely watched valuation metric recently hit its highest level in over four years.

In a note this week, Morgan Stanley equity strategist Michael Wilson wrote that weak jobs data combined with tariff-related inflation worries could trigger a pullback, especially during the seasonally soft third quarter. Still, Wilson maintained a bullish 12-month outlook, adding, "We would buy the dip."