A key U.S. inflation report looms over Wall Street. How to trade it

The October personal consumption expenditures price index report has many investors wondering how it may impact the postelection market rally. The S & P equal weight index has outperformed the market cap-weighted S & P 500 since Nov. 5. On top of that, more than 100 S & P companies hit new highs on Monday. Economists polled by Dow Jones expect headline PCE to have risen 2.3% year over year. Core PCE, which strips out food and energy prices, is forecast to have expanded by 2.8% in October. William Lee, chief economist at the Milken Institute, said a hotter-than-expected report can change the Federal Reserve’s outlook on rate cuts which could impact investor sentiment. “It definitely threatens the dynamic of the market broadening because it jeopardizes the speed at which the Fed drops interest rates,” Lee told CNBC. “Right now, the markets are pricing out interest rates one by one. To me that is a sign that people are wary that the Fed will realize that inflation has not been going down at the speed they had hoped.” Traders are currently pricing in a 59% chance of a rate cut in December, per the CME Group’s FedWatch tool. How to play a hotter-than-expected PCE Jimmy Lee, CEO of the Wealth Consulting Group, said buying “Magnificent Seven” stocks ahead of the report is a safe way to play potential volatility and a higher-for-longer environment. These include Nvidia, Meta Platforms and Microsoft. “We’ve seen investors walk into this as interest rates were going higher because they produce a lot of cash flow and they don’t depend on any bank financing. I think that is a good way to hedge that,” said Lee. Victoria Greene, CIO of G-Squared Private Wealth, said that if investors are anticipating a hotter-than-expected PCE, she recommends buying Amazon or TJX . “Slightly hot indicates strong consumer income growth, so I would lean into discretionary spending leading into the holiday,” said Greene. Bill Baruch, president of Blue Line Futures, sees opportunities in the currency and bond markets if core PCE rate reaches 3%. “You want to be long on the dollar, the dollar move move higher on that report,” Baruch said. He added: “You want to short the 2-year Treasury. If we start seeing inflation get back above 3% you start seeing these rate cuts priced out. It’s going to have a larger impact on shorter duration. ” How to play a cooler-than-expected PCE Malcolm Ethridge, managing partner at Capital Area Planning Group, says investors betting PCE will come in below estimates should reassess their bond positioning. “This PCE report and the expectation for a December cut are going to create quite a bit of volatility in fixed income,” Ethridge told CNBC. “People who are in a 60/40 balanced type of portfolio that has significant weighting in fixed income should determine if they feel appropriately allocated at today’s prices.” Ethridge added that investors expecting a PCE below expectations should buy the dip on megacap tech stocks that have traded lower in recent sessions, including Nvidia . “Anyone who feels they are under allocated to the Mag 7 would want to be buying any of those names with the expectation of a cut that is going to send market up.” Greene sees opportunity in financials if PCE is below expectations. “I like finance names like [U.S. Bancorp] or Goldman Sachs who have shown an ability to keep net interest income growing even in a time of slow rate cuts.” Baruch thinks a potential rally out for the Russell 2000 is possible in this scenario, even after it hit an all time intraday high Tuesday. “They have been very responsive to lower rates,” Baruch said. “Another 3%, 4%, 5% higher that is what you are looking at. You are looking for a real breakout there.”