The Fed's Preferred Inflation Gauge Reports on Thursday. It Could Send Stocks Lower.

Inflation is among the biggest threats to the stock market right now.

Concerns about inflation have driven bond yields significantly higher in recent weeks. If that yield increase continues, it could do serious damage to stock prices and undermine the bull market rally that began in April 2025.

Investment bank Goldman Sachs warned of this in a note published last week: "There is a growing risk that rising bond yields, along with a slowing economy or inflationary pressures, could trigger a stock market correction."

The next few inflation updates will be absolutely critical to the stock market's ability to keep climbing.

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The first of those readings comes on Thursday morning, when the Commerce Department's Bureau of Economic Analysis will release the Personal Consumption Expenditure Price Index for April. The PCE Price Index is the Federal Reserve's preferred measure of inflation because it is more comprehensive and more quickly reflects changes in consumers' choices in response to price changes.

In March, the headline PCE Price Index increased 3.5% year over year. It was up 3.2% when volatile food and energy prices were stripped out, for what's known as Core PCE.

Many analysts think Thursday's inflation reading could be higher than expected

Analysts think the inflation generated by rising oil prices -- a result of the ongoing war in the Middle East -- may surprise to the upside in Thursday's PCE report, based on recent inflation readings in the Consumer Price Index (CPI) and the Producer Price Index (PPI). CPI rose 3.8% year over year in April, and 2.8% with food and energy prices excluded. PPI, a measure of producer and wholesaler inflation, rose 6%.

The Fed's target for consumer price inflation is 2% per year, so the recent readings are far higher than what it's looking for.

The Cleveland Federal Reserve's Inflation Nowcasting model forecasts that PCE for April will come in at 3.81% (3.31% for Core). The model expects those to increase to 4.06% (headline) and 3.36% (core) for May.

If the PCE data surprises to the upside of those expectations, it could easily rock the stock market. That's because rising inflation will exacerbate the recent sell-off in the bond market, driving prices down and yields higher. Higher yields, which determine many consumer and business borrowing rates, mean that financing will become more expensive across the economy, driving down businesses' revenues and profits.

Both the S&P 500 index and the Nasdaq Composite set new highs this week, mostly on optimism about a peace deal with Iran. But Thursday's PCE reading could undo many of those recent gains.

Matthew Benjamin has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group. The Motley Fool has a disclosure policy.