By Maksym Misichenko · Nasdaq ·
What AI agents think about this news
The panel consensus is bearish, with the main concern being the potential impact of persistent energy-driven inflation on equity multiples, despite some disagreement on the Fed's reaction function and the role of fiscal policy.
Risk: The risk of energy-driven input cost inflation persisting long enough to corrupt core inflation expectations and compress equity multiples, particularly for high-multiple tech stocks.
Opportunity: None explicitly stated.
This analysis is generated by the StockScreener pipeline — four leading LLMs (Claude, GPT, Gemini, Grok) receive identical prompts with built-in anti-hallucination guards. Read methodology →
Inflation is a crucial economic indicator, and understanding it can help investors make more-informed decisions. It's primarily measured by the Consumer Price Index (CPI), which tracks the change in price of a basket of goods and services on a year-over-year basis.
The Federal Reserve will adjust the federal funds rate (the overnight interest rate) when the CPI deviates too far from its annualized target of 2%. The Bureau of Labor Statistics (BLS) just released its inflation report for May, and the CPI surged to an annualized rate of 4.2%. The last time it was above 4% was April 2023, and the Fed was aggressively increasing interest rates.
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As a result, Wall Street is now forecasting at least one interest rate hike by the end of this year, and here's why the move could derail the momentum in the S&P 500 stock market index.
After defeating the inflation surge from 2022 that saw the CPI explode to 8%, the Fed has cut interest rates six times since September 2024. But the ongoing conflict between the U.S. and Iran has driven a surge in oil prices, with a barrel of West Texas Intermediate crude currently trading for $90, which is 56% higher than where it started the year.
Iran continues to restrict commercial shipping lanes in the Strait of Hormuz, through which 25% of the world's seaborne oil transits every day. The subsequent rise in energy prices is affecting the cost of every product that travels by ship, plane, and truck, so consumers are feeling the pain not only at the gas station, but also at the grocery store and at their favorite retailers.
The Producer Price Index (PPI), which measures the change in the price of input costs for businesses, came in at an annualized rate of 6.5% in May, with the energy component alone surging to 36.6%. Businesses will probably pass at least some of those increased costs on to consumers, so the price of goods and services could trend even higher over the next few months.
That doesn't bode well for the CPI, which is already increasing at twice the rate of the Fed's 2% target. In April 2023, when the CPI last soared by over 4%, the effective federal funds rate was 4.8% -- a full 120 basis points higher than where it is today. In other words, the Fed will have to execute five 25-basis-point rate hikes if it wants to fight inflation with the same level of force as it did back then.
According to the CME Group's FedWatch tool, which analyzes the 30-day fed funds futures market to predict potential interest rate moves, Wall Street thinks there is a 66% chance of at least one rate hike by December.
During the entirety of the Fed's last rate-hiking cycle, which started in March 2022 and ended in August 2023, the S&P 500 delivered practically no return. It actually fell by more than 20% from its peak during that window, which constituted a technical bear market.
Rising interest rates are bad for the stock market for a few reasons. First, they increase the yield on risk-free assets like cash and government bonds, giving investors some very attractive alternatives. Second, rising rates force consumers to allocate more of their household budget to debt repayments, leaving them with less money for discretionary spending.
Third, businesses don't have as much borrowing capacity when rates are rising, so they can't invest as aggressively in growth. Lastly, higher interest costs can directly reduce a business' profits. Together, these factors can be a serious drag on corporate earnings, and earnings drive stock prices over the long term.
On that note, the S&P 500 currently trades at a cyclically adjusted price-to-earnings (CAPE) ratio of 41, so this is officially the second-most expensive stock market in history behind the dot-com internet bubble in the year 2000.
Since the S&P 500 is starting from such a high valuation, a series of interest rate hikes could legitimately threaten the current bull market. However, as was the case after 2022, the index is likely to recover to new highs over the long term, so investors should be on the lookout for buying opportunities if there is a significant downswing.
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Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends CME Group. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Four leading AI models discuss this article
"A 41 CAPE plus renewed rate-hike odds creates asymmetric downside risk for the S&P 500 even if inflation proves transitory."
The article flags May CPI at a 4.2% annualized pace—last seen in 2023 when the Fed was still hiking—plus a 6.5% PPI print and 36.6% energy spike tied to Iran-related oil at $90. With the S&P 500 at a 41 CAPE, even one or two 25 bp hikes (66% odds per FedWatch) could pressure multiples via higher discount rates and reduced consumer/business spending. Energy pass-through into core services is the under-discussed transmission channel that could keep inflation sticky beyond the initial oil shock.
If the spike is purely energy-driven and reverses within two quarters, the Fed can look through it the same way it did in 2022-23, leaving the rate path unchanged and valuations intact.
"Near-term, the S&P 500 faces meaningful downside pressure from higher discount rates and stretched valuations, even as selective AI beneficiaries outpace."
While the CPI 4.2% print and Fed rate-hike chatter grab headlines, the bigger question is the robustness of the 'higher for longer' regime and how financial conditions feed into earnings. The article treats rising rates as sure-fire stock-market kryptonite, but much of the most overvalued parts of the market are beneficiaries of AI capex, buybacks, and resilient cash flows, which can support multiples even with modest rate hikes. What it misses: the path of core inflation, services, shelter, and the Fed's policy reaction function. If inflation cools or growth softens, rates may stay lower longer, cushioning draws on the S&P 500. Also the energy shock risk is asymmetric.
Strongest counterargument: markets have largely priced in a shallow hike path; if inflation softens and financial conditions ease, the Fed may pause or cut, letting earnings surprise and risk assets rally.
"The combination of a 41x CAPE ratio and a 6.5% PPI suggests that corporate margins are about to face a severe compression that the current equity pricing does not reflect."
The article’s premise of a 4.2% CPI print is a massive red flag, but the real risk isn't just rate hikes—it's the 'stagflationary trap.' A CAPE ratio of 41 is historically unsustainable, yet the market is pricing in a 'soft landing' that ignores the supply-side shock of $90 WTI crude. If the Fed hikes, they risk breaking the labor market; if they hold, they risk unanchored inflation expectations. I am bearish on the broad market, specifically high-multiple tech, because the market is currently mispricing the cost of capital. We are seeing a classic disconnect between equity valuations and the reality of persistent, energy-driven input cost inflation.
The market may be discounting the CPI spike as a transitory supply-chain hiccup, and if the Fed signals a pause rather than a hike, the sheer momentum of AI-driven productivity gains could force a valuation expansion regardless of interest rates.
"The inflation scare is real but narrowly sourced to oil; the Fed's actual move depends entirely on whether core CPI follows energy higher over the next two months."
The article conflates two separate problems: energy-driven CPI (transitory, geopolitical) with sticky core inflation (structural, persistent). May's 4.2% CPI is heavily weighted to energy—PPI energy surged to 36.6%—but core CPI data isn't mentioned. The 2022-23 comparison is misleading: then, demand-pull inflation was broad-based; now, it's supply-shock driven. Critically, the article assumes Fed hiking is imminent based on CME's 66% probability, but that's pricing in *possibility*, not consensus. The CAPE ratio concern is valid, but valuations compress through earnings growth, not just multiple contraction. The real risk isn't rate hikes—it's whether energy prices stay elevated long enough to corrupt core inflation expectations.
If energy prices normalize (Iran tensions ease, OPEC production rises, or demand softens), May's CPI spike becomes a one-month blip, and the Fed stays on hold. The market has already priced in one hike by year-end; surprise *cuts* later in 2025 would be far more bullish than expected.
"Lingering $90 oil transmits into services wages, shifting Fed dots beyond current pricing."
Claude rightly flags the energy-versus-core distinction, yet the $90 WTI level tied to Iran supply risks could linger into Q4, lifting transportation costs that feed directly into services wages. That channel would alter the Fed's reaction function faster than the 66% hike odds reflect, compressing multiples on AI-heavy names even if headline CPI mean-reverts. The 2022-23 parallel understates this persistence risk.
"Even if core inflation cools, a persistent energy shock can tighten financial conditions and compress equity valuations through higher real rates and credit spreads."
Claude's energy-core distinction is helpful, but it underweights the financial channel. Even if core inflation reverts, a sustained energy shock raises real rates and widens credit spreads through energy-linked borrowers, tightening financial conditions and compressing multiples across capex-heavy equities (not just those exposed to AI). If the Fed reacts to higher real rates or tighter financial conditions, the 'soft landing' scenario looks harder. The risk premium stays elevated even with a cooled CPI.
"Persistent fiscal deficits will drive long-term yields higher, pressuring equity multiples even if the Fed remains sidelined."
Gemini and Grok are hyper-focusing on the Fed's reaction to energy, but they ignore the fiscal impulse. With the US running a ~6% deficit, the Treasury’s bond issuance is the real anchor for the 10-year yield, not just CPI prints. Even if the Fed pauses, the term premium will rise as supply outstrips demand. This forces a higher discount rate on long-duration tech, regardless of whether the Fed hikes or stays on hold.
"Fiscal issuance raises yields only if the Fed's reaction function shifts; energy inflation's effect on Fed *messaging* may matter more than Treasury supply mechanics."
Gemini's fiscal anchor argument is underspecified. Yes, Treasury issuance matters, but the 10-year yield has fallen despite deficit expansion before (2017-19). The real question: does energy-driven inflation push the Fed to *signal* higher-for-longer rates, which then anchors term premium independent of fiscal supply? That's the transmission ChatGPT flagged. Fiscal drag alone doesn't force multiple compression if real rates stay stable.
The panel consensus is bearish, with the main concern being the potential impact of persistent energy-driven inflation on equity multiples, despite some disagreement on the Fed's reaction function and the role of fiscal policy.
None explicitly stated.
The risk of energy-driven input cost inflation persisting long enough to corrupt core inflation expectations and compress equity multiples, particularly for high-multiple tech stocks.