New US inflation data due this week could prove "critical" for the overall direction of financial markets, according to analysts at Wolfe Research.
"In the absence of a US-Iran settlement, we believe higher-than-expected inflation will likely be a negative catalyst for equities and could trigger a short-term sell-off in markets," Wolfe strategists said in a note. "Markets are indeed approaching a crossroads depending on the direction of oil prices."
The May Consumer Price Index (CPI) will be released on Wednesday. Analysts expect the headline figure to rise to 4.2% year-over-year, up from 3.8% in the previous month. Monthly CPI growth is forecast to slow to 0.3% from 0.6%.
The core CPI, stripped of volatile components like food and fuel, is expected to accelerate to 2.9% year-on-year and 0.5% month-on-month.
The separate producer price index is forecast to decline to 0.7% from 1.4% month-on-month. The core producer price index is expected to reach 0.5%, down from 1.0%.
Against this backdrop, tensions in the Middle East continue to simmer. On Monday, Iran and Israel announced a temporary halt to mutual attacks, but, according to media reports, did not rule out the possibility of further escalation.
This news comes after renewed strikes between Iran and Israel cast doubt on President Donald Trump's ability to reach a long-term peace agreement with Tehran.
Brent crude oil prices, the global benchmark, pared some of their earlier gains. The contract is trading below recent highs, but remains well above pre-war levels.
Concerns persist that the energy shock could fuel inflationary pressures globally, which in turn could force central banks to raise interest rates. In particular, the Federal Reserve is expected to raise rates before the end of the year, especially following strong US employment data last week.
"US markets are shifting to a heightened sensitivity to inflation and employment trends amid persistently high oil prices," Wolfe analysts noted.
However, they added that if markets weather this week's inflation data release without any negative surprises, "information flow will likely return to artificial intelligence and the planned SpaceX IPO, which should rekindle risk appetite."