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Worse-than-expected CPI results could derail stocks.
Scott Olson/Getty Images
While the stock market has been enjoying an impressive run lately, the party could be over when the next inflation result comes out in early August.
The
S&P 500
has gained 13% since hitting its lowest close of the year in mid-June, capping a broad rally that includes more than a handful of stocks. Technology-heavy
Nasdaq Composite
is up 16% from its mid-June low and h
The Russell 2000 index of stocks with smaller market capitalizations is up 14%.
The main force behind this was investors’ view that the Federal Reserve will begin to slow the sharp interest rate hikes it has developed as it seeks to reduce the rate of inflation by curbing economic demand. While the Fed will likely raise its key lending rate target at its next policy meeting, the chance it will raise rates above 3.5% by February has fallen to 17% from a 44% chance before one month. according to CME Group data.
The bank now aims to keep its benchmark rate, the Fed-funds rate, at 2.25%-2.5%, up from near zero at the start of the year.
Contributing to this more optimistic view of interest rates are two key points that the rate of inflation has already peaked. Commodity prices are now well down, with West Texas Intermediate crude down about 14% since early June and copper about 16%. Not only is oil part of the CPI basket, but it is likely that the drop in commodity prices reflects a decline in demand across the economy.
Another sign that prices could fall came in the S&P Global US Services Purchasing Managers Index, a measure of activity in the services sector. This fell to 47 in July, while anything below 50 represents a contraction in activity. If activity declines, demand will also decline, lowering prices.
Markets will see if this bullish stance holds when the consumer price index is released on August 10. Economists are looking for the CPI to have risen 8.8% year-on-year in July, which would be below the 9.1% seen in June.
For stocks to continue to rise, the market needs to see that inflation is actually falling. If the outcome is worse than expected, expectations that the Fed will slow its rate hikes could disappear, sending the stock market lower.
“The Fed should be concerned that inflation is becoming more entrenched and should remain aggressive in raising rates,” wrote Chris Zaccarelli, chief investment officer at the Independent Advisor Alliance. “We think the rally will last until later in the summer. The markets will again have a new sell-off.”
Others agree. “[Stock] Profits now depend on data,” wrote Julian Emanuel, equity strategist at Evercore.
That’s hardly a clear signal to aggressively buy stocks now.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
