After years of battling the rising cost of living, Americans are finally getting some relief. U.S. inflation fell 0.1% month-on-month in June, beating analysts’ consensus forecast for a 0.1% increase, in keeping with the Bureau of Labor Statistics. reported Thursday. On an annual basis, consumer prices also rose by only 2.97% – the smallest increase in over three years.
“The expectations were that this would be a good report. But as you can see, it was better than expected,” said Bill Sterling, global strategist at GW&K Investment Management Assets the buyer price index (CPI) data.
A 3.8 percent drop in gasoline prices accounted for many of the decline in inflation in June, but core inflation, which strips out more volatile food and energy prices, also got here in lower than expected. Slowing growth in housing costs meant core inflation rose just 0.06 percent month-on-month and about 3.3 percent year-on-year – one other three-year low.
After the Federal Reserve fought inflation for years with relatively high rates of interest, skilled investors had long predicted that the central bank would win the battle against rising prices. But they were repeatedly disenchanted. But this time, many experts are convinced that the Fed finally has inflation under control and that rate of interest cuts are on the best way.
“All in all, it was a very encouraging report from the Fed’s perspective. And the markets are now pretty convinced that this will lead to a Fed rate cut in September,” Sterling said.
Why you must expect rate of interest cuts
The optimistic outlook following the CPI report was palpable across Wall Street. Citi economist Veronica Clark noted that inflation in June was “below already low expectations,” suggesting that the stronger-than-expected inflation in the primary quarter was likely “an aberration.” Now, especially with housing inflation easing, the Fed must have the green light to chop rates by September, Clark argued in a note to clients on Thursday.
Housing inflation has been a thorn in Fed Chairman Jerome Powell’s side for years. Over that point, nevertheless, numerous analysts and economists, including Jeremy Siegel of Wharton University, have identified that the Fed’s measurements often lag behind reality, where home and rental price growth has cooled.
Eric Pachman, chief analytics officer at Bancreek Capital Advisors, believes we’re finally seeing signs that the declining housing cost metric is moving more according to current prices. That’s crucial because housing cost inflation alone accounts for a couple of third of the buyer price index. “We finally have at least one data point to rely on. Maybe I’m exaggerating, but I’m pretty excited,” he said of the housing cost inflation data.
Brian Rose, senior U.S. economist at UBS Global Wealth Management, echoed Clark and Pachman’s optimistic comments, but added that the recent rise within the unemployment rate could give Fed officials further ammunition to pursue a more dovish monetary policy. “With both inflation and the labor market weakening, the door now appears wide open for the Fed to begin cutting interest rates,” he said. Assets by email.
The probability of a rate cut in July based on Fed funds futures contracts – which offer insight into bond market investors’ expectations – rose after the CPI report, but continues to be below 10%, in keeping with CME. FedWatch ToolHowever, the percentages of a rate cut in September have risen from around 50% after last month’s CPI report back to 98% on Thursday. And in December, the percentages of no less than one rate cut are almost 100%.
Why have stock prices fallen?
Normally, rate of interest cuts are seen as positive for stock markets. Lower rates mean lower borrowing costs, which implies extra money for corporations to speculate in growth. But two out of three major indices fell after Thursday’s subdued consumer price index, which signaled that rate cuts are more likely than ever.
The blue-chip S&P 500 index fell 0.88 percent, while the tech-heavy Nasdaq slumped about 1.95 percent. Interestingly, nevertheless, an equally weighted version of the S&P 500 – one that doesn’t skew exposure to corporations based on their market capitalization – actually rose greater than 1.21 percent.
“Is the market down? Or is this the most extreme rotation we’ve ever seen from everything people have been hiding in?” asked Pachman of Bancreek Capital Advisors when confronted with this data.
The reality is that the majority stocks didn’t fall on Thursday, he noted, but the large tech and AI stocks which have euphoric investors over the past two years definitely fell. This shouldn’t be a broad-based stock market decline in the intervening time, but a long-predicted reallocation by investors into more value-oriented offerings.
Until then, shares of leading technology corporations, which had risen sharply in recent times and created probably the most concentrated markets in history, fell sharply on Thursday. Nvidia lost 5.6 percent, Apple slumped 2.3 percent, Microsoft lost 2.5 percent and Tesla lost 8.4 percent.
Pachman was not alone in his investor rotation diagnosis. Eric Wallerstein, Chief Investment Officer at Yardeni Research, said in a post on X (formerly Twitter) Thursday. Wallerstein noted that investors on Thursday were moving en masse away from growth-oriented large caps and into predominantly value-oriented small and mid caps.
That’s not entirely illogical considering that the small-cap S&P 600 index trades at just 13.9 times forward earnings, while the large-cap S&P 500 index trades at over 21 times forward earnings. Small caps, which on average carry far more debt than their large-cap counterparts, have suffered under a regime of upper rates of interest, but that might change.
Small caps were trading at lower than half the valuation of mega caps 8. A small rotation is smart. https://t.co/HHHMkqPYI9 pic.twitter.com/6MUVITwQB2
— Eric Wallerstein (@ericwallerstein) July 11, 2024
The second possible explanation for the weakness in equity markets after the optimistic Consumer Price Index (CPI), especially in big technology and growth stocks, is solely that the market has rallied in anticipation of rate cuts in 2024. Even after its decline on Thursday, the S&P 500 continues to be up about 17% year-to-date, and the Nasdaq Composite is up about 23% on the back of the AI boom.
“Share prices have risen so much for such a long time that one could argue [the] “The good news was already predictable,” said Sterling of GW&K Investments.
In his view, it is not necessarily surprising that inflation is falling, especially with so many once-hot price categories falling sharply. And which means many investors have likely priced in falling rates of interest when valuing stocks. Take lumber, for instance, where futures prices have fallen greater than 75% since their 2021 peak. Or used cars, where the national average price has fallen from its 2022 peak of over $30,000 to simply $18,000. $25,328.
Perhaps market participants ultimately simply listened to the classic Wall Street tip given to inexperienced investors on Thursday: Buy the rumor, sell the news.
