A much-awaited inflation report and elevated bond yields offer the latest <a href="https://www.thenationalnews.com/business/markets/2023/07/01/how-global-markets-performed-in-first-half-of-2023/" target="_blank">test to a US stock rally</a> that has delivered hefty gains this year. The benchmark S&P 500 index is up 16.6 per cent year-to-date, driven by an improving economic outlook, excitement over <a href="https://www.thenationalnews.com/business/technology/2023/07/21/generative-ai-set-to-boost-global-labour-productivity-in-next-decade/" target="_blank">developments in artificial intelligence</a> and signs that the Federal Reserve is close to ending its series of interest rate rises. Stocks' near-term trajectory, however, may depend on whether next week's inflation report shows consumer prices remaining subdued. Investors are also closely watching the path of Treasury yields, which rattled equity markets in recent days by rising to year highs. The S&P 500 fell 2.27 per cent this week, its biggest weekly decline since March 10. “After a massive run-up in equities … any sort of blip in terms of any of the macro data [is] probably going to be a reason for people to take profits,” said Jack Janasiewicz, lead portfolio strategist and portfolio manager at Natixis Investment Managers. While consumer prices have not been rising as fast lately, some investors worry stubborn inflation may force the Fed to leave rates at current levels longer than expected. The US reports consumer price data on August 10. On Friday, US employment data showed the economy maintained a moderate pace of job growth. Yet wages grew at a faster-than-expected annual clip of 4.4 per cent. Many fear that is too high to be consistent with the Fed's 2 per cent inflation target. Mr Janasiewicz said a stronger-than-expected consumer price reading next week could spark a decline of up to 5 per cent in the S&P 500. He said such a drop would be “healthy” given the index's big run-up this year. Other investors have been taking profits. Concerns over rising stock valuations pushed Aaron Chan, a managing partner at equity hedge fund Recurve Capital, to trim stakes in shares of companies including Amazon.com, which is up 68 per cent this year, and Norwegian Cruise Line, up 47 per cent. The S&P 500 is trading at about 19.5 times forward 12-month earnings estimates, much pricier than its long-term average of about 15.6 times, according to Refinitiv Datastream. Rising global prices for oil and food, which the Fed's rate increases do little to control, may have more sway on inflation in coming months, said Tim Murray, a capital markets strategist at T Rowe Price. Prices for Brent crude were on track for their sixth week of gains in a row, up roughly 17 per cent in that period on signs of tightening global supply and rising demand. “As long as CPI remains flat to trending down, the market will accept it thoroughly,” said Ann Miletti, Allspring's head of active equity. “If we do see upticks, it is really dependent on where the upticks are and whether or not investors believe they're temporary in nature.” Ms Miletti is growing more bullish on corners of the market that have underperformed, including small cap stocks. A stronger-than-expected inflation number next week could also boost Treasury yields further. Yields, which move inversely to bond prices, spiked this week following <a href="https://www.thenationalnews.com/business/economy/2023/08/02/fitch-downgrades-us-credit-rating/" target="_blank">a downgrade of the US credit rating by Fitch</a> and on the prospect of a flood of Treasury supply in the third quarter. The benchmark 10-year yield fell sharply after <a href="https://www.thenationalnews.com/business/economy/2023/08/04/us-hiring-slows-in-july-as-unemployment-dips/" target="_blank">Friday's jobs report</a> but remained above 4 per cent, a level last seen in November 2022. Rising yields on Treasuries, viewed as among the world's safest investments because they are backed by the US government, can dull the allure of stocks. Projected company cash flows are also worth less in current dollars when interest rates rise. “The move in the 10-year US Treasury yield above the 4 per cent level will be likely to act as a headwind to further expansion in already lofty equity valuations,” Keith Lerner, co-chief investment officer at Truist Advisory Services, wrote this week. There is still plenty of good news to keep the rally going. Earnings from Wall Street heavyweights Amazon and Google-parent Alphabet have exceeded analysts expectations, though disappointing earnings from Apple sent the stock tumbling 4.8 per cent on Friday. More broadly, more than 79 per cent of S&P 500 companies have beaten estimates for the second quarter so far, the highest beat rate since the third quarter of 2021, data from Refinitiv showed. In the past week, analysts from BofA Global Research and JPMorgan revised their forecasts for a US recession. Still, some market participants believe investors may have to endure some near-term turbulence. “Our expectation is that the market takes some time to digest the strong year-to-date gains and moves into a choppy period,” Mr Lerner said.