The S&P 500 (^GSPC 0.25%) has advanced 28% year to date through the first week of December. That puts the benchmark index within striking distance of 30% upside in 2024, which would be its best annual peformance of the 21st century. But the stock market has a make or break week ahead.

Interest rate cuts have factored heavily into the S&P 500's historic run, and the current pricing of futures contracts implies an 86% chance the Federal Reserve cuts rates at the December meeting. But whether that actually happens depends on inflation data due on Wednesday and Thursday this week.

If those reports align with expectations, the stock market could move sharply higher as investors become more confident in a December rate cut. But if inflation exceeds expectations, the stock market could move sharply lower as investors become less confident. Read on to learn more.

The Federal Reserve got a few things wrong when it started cutting rates in September

The Federal Reserve is charged with promoting stable prices and maximum employment. It balances those goals by raising and lowering the target federal funds rate. Higher rates slow the economy, which leads to lower inflation but more unemployment. And lower rates stimulate the economy, which leads to higher inflation but less unemployment.

The current cutting cycle started with a half-point reduction in the federal funds rate in September, but that was based on assumptions that have since proven inaccurate. Specifically, the Fed estimated GDP would climb 2% in 2024, but it increased 2.8% in the third quarter. The Fed also estimated unemployment would hit 4.4% in 2024, but it peaked at 4.3% in July. That means the economy and jobs market are stronger than policymakers anticipated.

Fed Chairman Jerome Powell made that point during an interview last week. "The economy is strong, and it's stronger than we thought it was going to be in September," he said. "Labor market growth is definitely stronger than we thought and inflation is coming a little higher. So, the good news is we can afford to be a little more cautious as we try to find neutral."

Reading between the lines, Powell is saying the Federal Reserve is not committed to more rate cuts this year, nor are officials committed to the four cuts they projected for next year. Whether rates keep falling depends on two inflation reports due this week: the Consumer Price Index (CPI) on Wednesday, and the Producer Price Index (PPI) on Thursday.

Image source: Getty Images.

Fresh inflation data is due on Wednesday and Thursday

CPI inflation measures price changes from the perspective of consumers. November data is due at 8:30 AM ET on Wednesday, Dec. 11. After falling for six consecutive months, CPI inflation accelerated to 2.6% in October. The consensus is that CPI inflation will accelerate again to 2.7% in November.

PPI for final demand tracks inflation from the perspective of producers. It serves as a leading indicator for the CPI because producers generally pass costs on to consumers. November data is due at 8:30 AM ET on Thursday, Dec. 12. After falling in three straight months, PPI inflation accelerated to 2.4% in October. The consensus is that PPI inflation will accelerate again to 2.5% in November.

The Federal Reserve will meet on Dec. 17 and Dec. 18, and will announce their decision concerning interest rates when that two-day event concludes. That means investors will have to wait another week to know how policymakers interprets the November CPI and PPI data. But if either number tops expectations, the odds of a December rate cut will drop, which could cause the stock market to tumble.

Alternatively, if the November CPI and PPI readings align with the consensus, the stock market could soar. And if policymakers cut rates at the December meeting, the S&P 500 could make history and finish the year up 30% or more. That would be its best performance of the 21st century.