The latest Consumer Price Index (CPI) report for June 2024 has sent ripples through the financial markets, potentially signaling a shift in both monetary policy and investor sentiment. Let’s break down the key points and their implications.
Cooling Inflation
June’s CPI data came in cooler than expected, showing a 0.1% decrease month-over-month – the first decline in almost two years. The annual inflation rate dropped to 3%, down from 3.3% in May and below the forecasted 3.1%. Core CPI, which excludes volatile food and energy prices, rose by just 0.1% monthly and 3.3% annually, also beating expectations. Key factors contributing to this cooling trend include:
- A significant drop in energy prices
- A 1.5% decrease in used vehicle prices (10.1% year-over-year decline)
- Only a slight increase in shelter costs
Core CPI was down to a 1-month annualized pace of only 0.8%, the slowest since January 2021 and well below pre-COVID norms. The single most important driver was shelter inflation, which finally showed the disinflation that most economists had been expecting. The bottom line is that inflation appears to be very close to the Fed’s target. So what does this mean for Fed policy?
Implications for Federal Reserve Policy
This softer inflation data strengthens the case for the Federal Reserve to consider rate cuts sooner than previously anticipated. Here’s what it means:
- Increased likelihood of a rate cut in September (88% vs. 59% 1-month ago)
- Market expectations now include the possibility of multiple rate cuts by year-end
- The Fed’s target 2% inflation rate seems more achievable, potentially accelerating the timeline for further monetary policy shifts
To top it all off, Federal Reserve Chairman Powell expressed some dovish sentiments early in the week as he focused on highlighting the potential negative economic consequences of keeping rates too high for too long. So, what did this do to the market?
Market Rotation
The soft inflation data brought a massive rotation in equities. Small-caps, which have lagged behind their larger counterparts all year, saw significant interest. The Russell 2000 was up over 3.5% on the day of the CPI data release, while the S&P 500 and Nasdaq were both down. And it wasn’t just small-caps, as other S&P 500 members also saw much better performance. The equal-weighted S&P 500 index (all companies get an equal weighting as opposed to the market cap weighting for the traditional index) outperformed the standard index by over 2%, the third-best day ever.
In addition to the equity rotation, yields dropped rather considerably. Both the 1-yr and 2-yr U.S. treasury yields fell about 20 basis points as traders priced in a greater likelihood of interest rate cuts.
Looking Ahead
The Federal Reserve will closely monitor inflation data to guide interest rate decisions. If the current trend persists, we may see a shift towards a more accommodative monetary policy shortly, including interest rate cuts, possibly by September. As always, the economic landscape can change rapidly. Therefore, the coming months will be crucial in determining whether this disinflationary trend is sustainable and how it will impact financial markets.
Economy
- Markets were positive again, however, the disparity was massive after the CPI report. The S&P 500 was up 0.9%, the Nasdaq was up 0.2%, and the small-cap Russell 2000 was up 6.0%.
- Producer prices in the U.S. increased 0.2% MoM in June, following an upwardly revised flat reading in May and above forecasts of 0.1%.
- Services prices increased 0.6%, mainly due to margins for machinery and vehicle wholesaling (3.7%).
- In contrast, prices of goods declined 0.5%, primarily due to a 5.8% decline in gasoline.
Stocks
- U.S. equities were in positive territory. Real Estate and Utilities were the top performers, while Communication Services and Consumer Staples lagged. Value stocks led growth stocks, and small caps beat large caps.
- International equities closed higher for the week. Developed markets fared better than emerging markets.
Bonds
- The 10-year Treasury bond yield decreased eight basis points to 4.19% during the week.
- Global bond markets were in positive territory this week.
- Corporate bonds led for the week, followed by high-yield bonds and government bonds.
