Consumer Price Index (CPI) and the PCE (Personal Consumption Expenditures) deflator are the primary inflation measures. The Fed officially targets PCE, not CPI. Non-Farm Payrolls (NFP), released monthly, measure labor market health — above-consensus prints signal economic strength but also potential Fed tightening. GDP growth rate (quarterly) provides the broadest economic output measure. ISM Manufacturing and Services PMI are leading indicators of business activity — readings above 50 signal expansion, below 50 contraction. Markets react to surprises versus expectations, not absolute levels. A CPI print 0.1% above the consensus estimate can move markets more than a data point 1% above normal if the surprise itself is unexpected.

The yield curve — specifically the spread between 10-year and 2-year Treasury yields — is the single most closely watched recession indicator. An inverted curve (2-year yield above 10-year yield) has preceded every US recession since 1955 with only one false positive. The mechanism: banks borrow short (at 2-year rates) and lend long (at 10-year rates); inversion compresses bank profitability, reducing credit availability, which slows business investment and consumer borrowing. The lag between inversion and recession onset is typically 12-24 months — the signal is early and real, but the timing is imprecise.

Federal Reserve interest rate decisions affect stock valuations through three channels simultaneously. The discount rate channel: every equity valuation is a discounted cash flow calculation, explicitly or implicitly. Higher risk-free rates increase the discount rate, mechanically reducing the present value of future earnings. A move from 0% to 4% in the risk-free rate reduces the fair P/E multiple on the entire equity market by roughly 20-30% before earnings change at all. This is exactly what happened in 2022: multiples compressed sharply before any earnings deterioration because rates rose so rapidly.

The earnings channel transmits slower but compounds the discount rate effect: higher rates slow economic growth (more expensive borrowing for businesses and consumers), eventually compressing revenues and margins. The re-rating channel: higher risk-free rates reduce the equity risk premium that investors demand — when Treasury bonds yield 5%, the extra return investors require for taking equity risk looks different than when Treasuries yield 0.5%. All three channels work simultaneously in a tightening cycle, which is why sharp rate hike cycles produce both multiple compression and earnings estimate cuts — a double compression that explains why equity drawdowns during rate cycles are often more severe than they first appear.

Markets sometimes rally on weak economic data. The mechanism: soft labor market data (high unemployment claims, weak NFP) increases the probability of Fed rate cuts, which boost equity valuations through the discount rate channel. This perverse dynamic — where economic weakness is bullish for stocks — holds specifically when the dominant concern is that the Fed is overtightening and the economy is decelerating toward recession, but not yet there. Investors price in the benefit of expected easing before it occurs.

The regime-dependence of this relationship is critical. 'Bad news is good news' holds when the market's primary fear is that the Fed will stay too tight for too long. It breaks — 'bad news is just bad news' — when economic data is so weak that genuine recession risk dominates. At that point, the earnings channel overwhelms the discount rate channel: the market fears that earnings will fall faster than the Fed can cut rates. Identifying which regime is operative (growth scare vs. genuine recession) is one of the hardest real-time macro judgments in investing.