Macro

Key Inflation Report Looms Thursday as Traders Eye Fed Rate Cut, S&P Hits 5,633

Traders expect Fed rate cut as June CPI report forecasts 3.1% annual rise, 0.1% monthly increase.

By Athena Xu

7/10, 16:04 EDT
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Key Takeaway

  • Traders are increasingly confident in a Fed rate cut, with CPI expected to rise 0.1% month-over-month and 3.1% year-over-year.
  • The S&P 500 hit a record high of 5,633.87 as markets rally on expectations of rate cuts later this year.
  • Fed funds futures indicate traders expect the Fed to hold rates steady in July and cut in September, reflecting shifting market sentiment.

Anticipated CPI Report

The upcoming Consumer Price Index (CPI) report for June, scheduled for release at 8:30 am ET on Thursday, is expected to solidify market expectations for the Federal Reserve to cut interest rates in the coming months. Economists surveyed by Dow Jones predict a 0.1% month-over-month increase and a 3.1% year-over-year rise in CPI. The core CPI, which excludes volatile food and energy prices, is forecasted to rise 0.2% from May and 3.4% since June last year. This report follows recent economic data indicating cooling inflation and economic growth, including a slight uptick in unemployment to 4.1% in June.

Matt Brenner, managing vice president of investments and product management at MissionSquare Retirement, noted, "The level on inflation is still elevated relative to the Fed’s [2%] target. The level on unemployment is still very low historically at 4.1%. But the trend in both is that unemployment is gradually starting to pick up and that inflation continues its downward trajectory." Brenner added that the Fed might now be focusing more on trends rather than levels, increasing the likelihood of a rate cut.

Market Reactions and Expectations

The CPI report comes amid a market upswing, with both stocks and bonds rallying in July. The S&P 500 reached a record high of 5,633.87 on Wednesday. Fed funds futures indicate that traders expect the Fed to hold rates steady at its meeting later this month and then cut rates in September. A month ago, the chances of another pause in September were nearly even, according to the CME FedWatch Tool.

Meghan Swiber, a rates strategist at Bank of America, suggested that the expected hold in July might limit the CPI report's market-moving potential. "Cooling activity and limitations on near-term cut pricing should confine market response in either direction," Swiber said. However, Tony Roth, chief investment officer at Wilmington Trust, believes that a cooler-than-expected inflation reading could trigger a stock rally, as some investors remain wary from earlier inflation spikes. "I don’t think that the market has fully appreciated the weakness in the economy, or the fact that inflation is clearly in the rear view mirror," Roth stated.

Fed's Stance and Economic Indicators

Federal Reserve Chair Jerome Powell, in his recent testimony on Capitol Hill, expressed concerns about holding interest rates too high for too long, which could jeopardize economic growth. Powell acknowledged the progress made in lowering inflation and cooling the labor market over the past two years but emphasized the need to balance risks between inflation and recession. "Reducing policy restraint too late or too little could unduly weaken economic activity and employment," Powell said.

The Fed's overnight borrowing rate currently stands at 5.25%-5.50%, the highest level in 23 years, following 11 consecutive hikes. Markets anticipate the Fed to begin cutting rates in September, with another quarter percentage point reduction by year-end. Powell highlighted the importance of "operational independence" for the Fed to effectively manage monetary policy.

Street Views

  • Matt Brenner, MissionSquare Retirement (Cautiously Optimistic on the market):

    "The level on inflation is still elevated relative to the Fed’s [2%] target. The level on unemployment is still very low historically at 4.1%. But the trend in both is that unemployment is gradually starting to pick up and that inflation continues its downward trajectory... For some time the Fed has been more focused on levels, and now it seems that they may be starting to tilt more towards a focus on trend. And if that’s the case, then the chances of a rate cut go up."

  • Tony Roth, Wilmington Trust (Neutral on CPI components):

    "We’ve seen medical services [be] pretty tame, and that’s important because medical services makes up a much bigger portion of the PCE, which is the more important of the two inflation prints."

  • Meghan Swiber, Bank of America (Neutral on market response):

    "Cooling activity and limitations on near-term cut pricing should confine market response in either direction."

  • Tony Roth, Wilmington Trust (Bullish if CPI reading cooler than expected):

    "I don’t think that the market has fully appreciated the weakness in the economy or the fact that inflation is clearly in the rear view mirror."