The recent release of a flurry of U.S. employment data has left investors uncertain about the future direction of the Federal Reserve’s monetary policy. However, this week’s June Consumer Price Index (CPI) report is anticipated to provide greater clarity for the stock market, revealing whether the Fed will need to continue its fight against inflation after pausing its aggressive series of interest-rate hikes last month, according to market analysts.
The June CPI report, scheduled for release on Wednesday at 8:30 a.m. Eastern, carries significant importance. Analysts believe that the report’s findings may either support a continued rally in the stock market or potentially halt the current positive momentum, as macroeconomic headwinds intensify and pose a threat to the ongoing rally.
Economists surveyed by Dow Jones expect the June CPI to show a 3.1% rise compared to the previous year, indicating a slowdown from the 4% year-over-year increase observed in the prior month. The core price measure, which excludes volatile food and fuel costs, is predicted to rise 5.0% from a year earlier, down from May’s figure of 5.3%.
Tony Roth, Chief Investment Officer at Wilmington Trust, stated that his team anticipates continued disinflation in June, particularly in the super-core inflation measure that excludes energy, food, and housing expenses. This measure tends to experience a slower decline than the broader gauge.
Roth mentioned to MarketWatch that if inflation weakens significantly, it would support the narrative that the Fed is nearing the end of its tightening cycle. However, Irene Tunkel, Chief Strategist of U.S. Equity Strategy at BCA Research, expressed caution about the stock market’s ability to sustain its rally due to overly bullish sentiment and already high expectations. Tunkel emphasized that any disappointment in the CPI data could lead to a market downturn, given the stock market’s current conditions.
Tunkel warned that despite improving economic expectations and favorable sentiment, it is premature to celebrate victory. The stock market remains vulnerable to potential disappointments, especially when monetary policy is restrictive, and valuations for technology companies are extended.
The stock market’s sentiment has shifted from fears of a “hard landing” in the first half of/2023 to hopes of a “soft landing” in the second half, following the Fed’s decision to leave benchmark interest rates unchanged in June. However, Fed Chair Jerome Powell noted that policymakers still anticipate further interest-rate increases this year to address inflation concerns, with some projecting two more quarter-point hikes in the second half of/2023.
Investors have been grappling with mixed economic data throughout the week. On Thursday, U.S. stocks experienced broad losses after private sector data revealed the creation of nearly half a million new jobs in June. This led to concerns about further Fed interest rate hikes as the labor market remains tight. However, a still-strong but weaker-than-expected June nonfarm payrolls report on the following day tempered fears, leaving investors divided about the potential impact on interest rate decisions.
According to the CME FedWatch Tool, Fed-funds futures traders priced in over a 92% probability of a 25 basis point increase in benchmark interest rates to a range of 5.25% to 5.5% later this month. Expectations for another quarter percentage point rise in either September or November slightly diminished but remained above 25%.
David Lefkowitz, Head of Equities Americas at UBS Global Wealth Management, highlighted the overall resilience of the U.S. economy based on the jobs data. He noted that the economy has proven to be more resilient than previously expected a few months ago.
Despite the differences in interpretation, Roth from Wilmington Trust believed that the labor market report signaled a significant shift and suggested that the Fed may not need to keep rates at elevated levels for an extended period. He characterized any further rate hikes as “insurance hikes” to combat inflation, rather than part of the Fed’s tightening path for the second half of the year.
Lefkowitz emphasized the importance of considering the interest rate movements within the broader context of the economy. He stated that the rate adjustments in/2023 primarily reflect a more favorable economic growth outlook rather than inflationary pressures. Lefkowitz added that the second half of/2023 could provide a better environment for corporate profit growth, with companies’ forward estimates showing improvement over the last three months.
However, Tunkel from BCA Research pointed out the conundrum between economic growth and inflation, which contributes to the current complex economic landscape. Strong growth often accompanies inflation, and the two tend to move in tandem.
During the week, the U.S. stock market recorded declines, with the Dow Jones Industrial Average experiencing its largest weekly decline since March. According to Dow Jones Market Data, the Dow dropped nearly 2%, the S&P 500 fell 1.2%, and the Nasdaq Composite declined 0.9% throughout the week.
