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Market Snapshot: As U.S. stock-market investors celebrate soft economic data, is bad news becoming bad news again on Wall Street?

With second-quarter earnings season now largely behind the market, stock investors have been focusing on the latest economic data. 

They have, for the most part, been reacting positively to “bad economic news,” or any data that may point to an economic slowdown. 

It’s been almost nine months since the trend emerged, as softening economic data and lower inflation may mean the Federal Reserve can stop raising interest rates, said Chris Fasciano, portfolio manager at Commonwealth Financial Network.

Traders in federal-funds futures, as of Friday, are pricing in an over 90% chance that the Fed will hold its policy interest rate unchanged at its September meeting, and a roughly 35% likelihood that the U.S. central bank will raise interest rates by 25 basis points in November. 

Read: The Fed’s monetary policy has lost some of its potency and interest rates may need to rise much higher as a result, economist says

U.S. stocks closed the week higher ahead of the Labor Day holiday weekend, after data released Friday indicated a cooling labor market, though there was speculation that a “mirage” concerning the conclusion of summertime jobs may have factored. The U.S. created 187,000 new jobs in August, while the unemployment rate jumped to 3.8% from 3.5%.

The data support the narrative of a gradual slowdown in the labor market, but there are no signs that the economy is weakening significantly, according to Richard Flax, chief investment officer at Moneyfarm.

Also read: ‘Near perfect’ jobs report has traders expecting Fed to be done hiking rates this year

“The economic data has not been bad. It is just softening. If you saw really bad economic data, that wouldn’t be taken particularly positively,” Flax said. 

Meanwhile, “what we’re experiencing is a rolling recession,” said Jamie Cox, managing partner at Harris Financial Group. “Recession activity actually goes from sector to sector, but it doesn’t translate into this big broad-based decline.”

However, if investors see a significant decline in the housing and labor markets, that could change the narrative, Cox noted. 

Read: Fed rate hikes can end now that U.S. job gains are the size of an economy like Australia’s, says BlackRock

To break the cycle in which bad economic news is good news for stocks, economic data have to be much worse than now, indicating more damage from high interest rates, noted Flax. 

The trend may also reverse if there is a “meaningful downgrade” of corporate earnings expectations, said Flax. “I think you need to see it when macro data translates into weakened profitability.”

Investors should also be alert of the possibility that inflation may accelerate again, according to David Merrell, founder and managing member at TBH Advisors. 

Data showed that the personal consumption expenditures price index rose a mild 0.2% in July, but the yearly inflation rate crept up to 3.3% from 3%, the government said Thursday.

“Inflation overall has been trending down nicely. But if it starts to kick back up, that could mean bad news becomes bad news now,” said Merrell. 

If investors start to treat bad economic news as bad news for the stock market, it could put pressure on the 2023 stock-market rally, with the S&P 500 SPX up 17.6% since the start of the year and the Nasdaq Composite COMP up 34%.

In the past week, the Dow Jones Industrial Average DJIA climbed 1.4%, the S&P 500 advanced 2.5% and the Nasdaq gained 3.2%, according to Dow Jones Market Data. The S&P 500 posted its biggest weekly gain since the week ending June 16.

This week, investors will be expecting data on the July U.S. international trade deficit and the ISM services sector activity for August on Tuesday, weekly initial jobless benefit claims data on Thursday, and the July wholesale inventories data on Friday. They will also tune into the speeches of a number of Fed speakers, looking for clues on whether the central bank is ready to be done with its rates hikes.

Economic calendar: On this week’s economic-data docket are the Fed Beige Book, factory orders, unemployment claims and more

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