An inflation reading on Friday could determine how May ends for the stock and bond markets

Inflation data is a wild card for the markets Friday, as traders watch to see if the economy is trapped in a period of sluggish price increases.

The data to be reported Friday at 8:30 a.m. ET is April’s personal consumption and expenditures, which includes the PCE deflator, an inflation reading tracked by the Federal Reserve. The inflation reading for the first quarter was revised lower to a surprisingly low 1% on the headline, from 1.2% in Thursday’s revised first-quarter GDP report. Quarterly PCE inflation data has only been that low two other times in the past six years.

Core PCE inflation for April is expected to rise by 0.2%, or 1.6% on a yearly basis, compared with a reading of zero last month, according to Dow Jones.

“The cat’s out of the bag a little. We had the GDP data come out with the quarterly deflator that was revised down and that’s got the market going here today,” said Tom Simons, Jefferies chief money market economist.

Treasury yields were lower Thursday, with the 10-year at 2.21%, well off the 2.55% where it started the month of May. As yields fell, stocks also sold off hard in May, and the S&P 500 is down 5.3% in May, as it heads to the final day of the month Friday.

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Since 1928, there have been 16 instances of the S&P 500 losing 4% or more in May, before this year. In June of those years, the S&P ended higher 63% of the time with a 1.7% gain. It also ended the June-October period higher with the same frequency, for an average gain of 6.5%.

“The thinking is the Fed needs to cut rates,” said Art Hogan, chief market strategist at National Securities. “If [PCE] comes in weak perhaps that puts the ‘the Fed is going to cut this year’ cohort of investors in a better mood, and maybe that puts a bid into this market.”

But instead of getting the normal boost on the idea of a Fed rate cut, the move lower in bond yields has been spooking stock investors and stocks have weakened with falling yields.

Hogan said he doesn’t believe the Fed needs to cut interest rates yet, but the fed funds futures market is betting on about 40 basis points of a rate cut by December.

“That brings the PCE more into focus than normal,” he said. “It’s a relatively robust data calendar, and obviously PCE comes into focus because we associate it so much with the Fed.”

Economists expect consumer spending jumped by 0.2% and income rose by 0.3%. Other data reported Friday includes Chicago PMI at 9:45 a.m. and consumer sentiment at 10 a.m.

“The PCE deflator is probably not going to change the narrative on inflation, because the market has selective hearing right now,” Simons said. “It likes to hear things about low inflation that add credence to the rate-cut argument, and it doesn’t like to hear anything to the contrary.”

The Fed has said it expects to meet its 2% inflation target and that it can overshoot it in both directions. Fed Chairman Jerome Powell jolted markets at the beginning of the month after he said the Fed sees low inflation as transitory and it should rise in the next couple of months, signaling the Fed would not have to cut interest rates. Powell said the Fed would also be happy to stay on hold until it has a clear signal in one direction or the other.

Since then, investors have reacted to weak economic reports by sending bond yields lower and betting on low rates in the fed funds futures market.