Three straight months of hot inflation data dented Wall Street’s confidence that a series of interest-rate cuts is set to start at any minute. Investors are hoping the fourth time is the charm.

A mood of renewed optimism about a soft landing for the U.S. economy has swept across trading desks in the days ahead of Wednesday’s release of the consumer-price index. Federal Reserve Chair Jerome Powell kept hopes of rate cuts alive following the central bank’s latest policy meeting. Subsequent data showed easing pressure from job and wage growth, helping propel stocks back toward records.

Lingering inflation has been the main issue troubling investors in recent months. Traders came into 2024 betting on as many as a half-dozen rate cuts, and then had to scale back those bets rapidly when the CPI kept topping expectations. That rattled stocks in April and sent bond yields, which rise when prices fall, to their highest levels since November.

Many investors said the April employment report eased some of their worries, because a cooler labor market should eventually lead to more-subdued price increases. Now, they just need actual inflation data to back that up.

“The CPI report could go a long way towards really furthering the narrative that rate cuts are coming this year,” said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities.

Stocks and bonds are closely linked. Yields on Treasurys are heavily influenced by investors’ expectations for short-term rates set by the Fed. Stock prices, in turn, are guided in part by investors’ weighing the risk-free return they can get from holding Treasurys to maturity.

The Dow Jones Industrial Average has already climbed 4.5% this month, bringing it to less than 1% below its record reached in late March. A rally in bond prices has driven the yield on the 10-year U.S. Treasury note down to 4.503% from 4.7% in late April.

Many investors believe the upside for bonds is larger than it is for stocks if inflation moderates. While stocks are already near records, the yield on the 10-year note remains well above the sub-4% level where it started the year.

Bond returns have disappointed over the past couple of years because interest rates climbed higher than investors had expected and then stayed at those levels for longer than anticipated. Nonetheless, investors have been quick to buy bonds at the slightest hint of easing inflation, anxious to lock in 4%-5% yields before the Fed starts cutting.

Ed Perks, chief investment officer of Franklin Income Investors, said he could see yields dropping as much as 0.2 to 0.25 percentage point on shorter-term Treasurys and 0.1 to 0.2 percentage point on longer-term Treasurys if data shows inflation moderating.

At the same time, he said, “It’s a bit more of a challenge to see a significant upward move in equities” given current stock valuations. For the same reason, he added, stocks probably have more room to drop if inflation is once again higher than anticipated.

Inflation has already fallen sharply from a peak in 2022. The question is whether it can get all the way back to the Fed’s 2% target, as measured by the central bank’s preferred personal-consumption expenditures price index.

Stripping out volatile food and energy categories, 12-month core PCE inflation dropped to 2.9% at the end of last year from 4.9% at the start of the year. But it has since stalled, standing at 2.8% at its latest reading in March.

Adding to the pressure on Wednesday’s CPI report: A quirk of the calendar means the report will offer investors a better-than-usual view of what PCE inflation will look like later in the month. 

That is because the PCE index includes both CPI and data on supplier-level prices.

Typically, the CPI data is released before the producer-price index report, leaving investors with some initial uncertainty about the Fed’s preferred gauge. But this month, PPI data will come first, on Tuesday, allowing investors to calculate PCE rapidly Wednesday morning. 

Many economists remain optimistic that inflation will resume its downward trajectory. Inflation in goods, they note, has already slowed to about where the Fed would like. Official measures of housing inflation have remained stubbornly high, but economists still expect them to moderate to come more in line with private-sector gauges of new rent increases.

Inflation in other types of services tends to move slowly both on the way up and on the way down. But the recent report showing cooling in the labor market was a positive sign, since the cost of labor tends to be a major driver of price changes in this category.

In addition, economists note that inflation in some types of services tends to lag behind inflation in related goods. For that reason, many expect increases in the cost of insuring or repairing a car to ease in the coming months, given what has already happened with new- and used-car prices.

Still, few at this point are underestimating inflation’s capacity to surprise in any given month.

George Mateyo, chief investment officer at Key Private Bank, said it still makes sense to own unconventional assets—such as real estate, inflation-protected bonds or international stocks—to hedge against another hot reading, given that a bad report would likely hurt U.S. stocks and bonds alike.

“We think that inflation is going to be somewhat sticky,” he said.