Inflation Report: Impact on Stocks This Week

A softer-than-expected inflation report could pressure the Federal Reserve to signal an interest rate cut is likely in September, or even open the door to one later this month.

Thursday’s inflation report is anticipated to be a key event for U.S. markets in a busy week that also includes the start of the second-quarter corporate earnings season, several Treasury debt auctions, and potential developments in the presidential election race.

The June consumer price index (CPI) numbers could have significant market implications, with investors particularly focused on this month’s data as it may influence the timing of the Federal Reserve’s first interest-rate cut.

A smaller-than-expected rise in inflation could encourage Fed Chair Jerome Powell to prepare the market for a rate cut at the Fed’s September meeting. Some analysts believe that a sufficiently weak number could even prompt a rate cut within weeks, despite futures-market traders viewing this as unlikely, according to CME Group data.

Conversely, a higher-than-expected reading, deemed unlikely by most economists, could halt the stock-market rally.

Tom Lee of Fundstrat and Neil Dutta of Renaissance Macro warned that Wall Street might be underestimating the possibility of a cut at the Fed’s July meeting. Lee suggested that another soft inflation reading could make a July cut possible, while Dutta noted that the chances of a July cut have been underpriced, arguing that the Fed should cut rates soon to avoid a more severe economic downturn.

If Thursday’s CPI data undershoot expectations, stocks are likely to rally alongside bonds as Treasury yields continue their recent decline. CPI data releases have typically caused notable stock market reactions since the Fed started raising rates in early 2022. This year, stocks have seen an average move of 0.9% on CPI days, nearly twice the S&P 500’s daily average move of 0.5%.

Any indication that the Fed might cut rates could boost lagging sectors of the market, such as small caps and interest-rate-sensitive stocks like those in the real-estate sector. Real estate has been the worst-performing S&P 500 sector over the past year, while the small-cap Russell 2000 index has moved slightly lower since the start of 2024.

Joseph Gaffoglio, president of Mutual of America Capital Management, suggested that a Fed rate cut could broaden market gains, although he doesn’t expect a cut soon and sees one cut later this year as more likely.

Economists polled by The Wall Street Journal expect headline inflation to slow to 3.1% year-over-year in June from 3.3% in May, with core inflation expected to remain steady at 3.4%.

Friday’s jobs data added weight to Dutta’s argument for a sooner rate cut, showing the labor market cooling with the unemployment rate at its highest since late 2021 and slower wage growth. Despite over 200,000 new jobs, revisions to prior months’ numbers brought the three-month average down.

Recent data indicate the economy is buckling under the highest interest rates in over 20 years. GDP growth in the first quarter was 1.4%, with the Atlanta Fed estimating 1.5% for the second quarter, down from 3.4% in the fourth quarter.

Powell acknowledged that earlier inflationary fears had passed and the U.S. economy is back on a disinflation path, but stated inflation may not reach the Fed’s 2% target until late 2025 or 2026. The Fed remains divided on how much more evidence of slowing inflation is needed, and whether a soft June report will be enough is yet to be seen.

Stocks rose on Friday as traders bet that the latest data would make a September Fed rate cut more likely. The S&P 500 gained 30.17 points, or 0.5%, to finish at 5,567.19, the Nasdaq Composite rose by 164.46 points, or 0.9%, to 18,352.76, and the Dow Jones Industrial Average gained 67.87 points, or 0.2%, to 39,375.87.