Thursday’s inflation report is expected to be at the forefront of a busy week for U.S. markets that will also see the start of the second-quarter earnings season, several Treasury auctions and potential developments in the presidential election.

Like all important economic data, the June Consumer Price Index (CPI) can have a significant impact on the market. Investors will be watching the data particularly closely this month because the timing of the first interest rate cut by the Federal Reserve is still up in the air.

If inflation picks up less than expected, it could at least encourage Fed Chairman Jerome Powell to more forcefully prepare for a rate cut at the September meeting, but some believe that if inflation data is weak enough, it could even open the door to a rate cut in a few weeks, which futures market traders see as highly unlikely, according to CME Group.

Meanwhile, most economists believe that even data that beat expectations is unlikely to prevent a stock market rebound.

Fundstrat head of research Tom Lee and Renaissance Macro head of U.S. economics Neil Dutta both warned on Friday that Wall Street may be underestimating the chances of a rate cut at the Federal Reserve’s July meeting.

Investors would do well to take their views seriously, as both have recently expressed outside-the-consensus views on the market and the economy.

"If this (CPI) records another weak reading, there is a chance that the Fed will cut rates at the July FOMC meeting," Lee said in written comments.

Dutta added in the interview that he thinks the chances of a rate cut in July are "underestimated." For the past few months, the economist has argued that the Fed needs to "cut the Gordian knot" and cut rates soon to avoid a more painful recession.

If Thursday's CPI data does come in below expectations, stocks could rally along with bonds as Treasury yields continue to slide in the near term.

CPI data has typically elicited a notable reaction in the stock market since the Federal Reserve began raising interest rates in early 2022, according to Dow Jones Market Data. To be sure, the magnitude of those swings has diminished as inflation has slowed.

Still, the average stock market move on CPI release dates has been 0.9% since the beginning of the year, nearly double the S&P 500’s 0.5% daily move as of last Friday.

Perhaps more importantly, any sign that the Federal Reserve may be close to cutting interest rates could help boost market sectors that have lagged behind the broader market. Wall Street pros say small-cap stocks and more cyclical, rate-sensitive shares, such as those in the real estate sector, could move higher.

Of the 11 sectors in the S&P 500, real estate has been the worst performer over the past year, while the small-cap Russell 2000 (RUT) has been slightly lower since the beginning of 2024, according to FactSet.

“When the Fed does cut rates, that could be a catalyst for broader market breadth,” Joseph Gaffoglio, president of Mutual of America Capital Management, said in an interview.

Gaffoglio started by saying he doesn't expect the Fed to move anytime soon to lower borrowing costs. He thinks the central bank will cut rates once, at most, later this year, in November or December.

Economists surveyed by The Wall Street Journal expect overall inflation to slow to 3.1% in June from 3.3% in May, while the more closely watched core inflation rate is expected to remain around 3.4% year-on-year.

Monthly employment data from the Labor Department due on Friday could help bolster Dutta’s argument that the Fed should act sooner rather than later. The report provides more evidence that the labor market has begun to cool.

In June, the unemployment rate climbed to its highest level since late 2021, while wage growth, seen as a reliable precursor to inflation, slowed. Meanwhile, while more than 200,000 new jobs were created, the data for the previous two months were revised down by a combined 111,000, affecting the three-month average.

The figures are consistent with other recent data showing that the economy is beginning to reel under the weight of the highest interest rates in more than two decades.

Official data showed that the US gross domestic product (GDP) grew by 1.4% in the first quarter, while the real-time indicator released by the Atlanta Federal Reserve showed that the GDP growth rate in the second quarter was expected to be 1.5%. In comparison, the GDP growth rate in the fourth quarter of last year reached 3.4%.

“GDP growth has clearly slowed,” Dutta said. The risk now is that the Fed’s view that it will keep interest rates higher for longer is outdated.

Others offered different interpretations of the latest labor market report, with some emphasizing that the rise in unemployment was due to more workers joining the labor force rather than mass layoffs.

Powell acknowledged at a recent central bank conference in Sintra, Portugal that the inflation scare earlier this year is over and the U.S. economy appears to be back on an anti-inflation track.

However, he added that inflation may not return to its 2% target until late 2025 or 2026 and that risks surrounding consumer prices and the labor market have returned to balance, meaning the Fed must treat both equally.

Minutes from the Fed’s most recent meeting showed officials remained divided over how much more evidence of slowing inflation is needed, though some said they were watching for signs the slowdown could deepen.

The article is forwarded from: Jinshi Data