Inflation Cools In May Ahead Of Fed Meeting, Reinforcing Thoughts A Pause Could Be Ahead

(Tuesday market open) U.S. consumer inflation continued easing in May, calming interest rate fears on Wall Street—at least for the moment.

Stock futures were mostly higher early Tuesday after the government said the May Consumer Price Index (CPI) rose 4% on an annual basis, the lowest in two years. That was below the 4.1% analysts had expected. The month-over-month rise of 0.1% for headline CPI was below analysts’ 0.2% forecast.

Core CPI, which strips out energy and food, rose 0.4% in May, equal to analysts’ expectations and unchanged from April. But overall, things looked cooler as the Federal Reserve gathers for its two-day meeting that culminates with tomorrow’s rate decision.

Checking yesterday’s action, info tech companies led sector gains, with the Philadelphia Semiconductor SOX index rising more than 7% and ending at a 16-month high. Consumer discretionary and retail were also strong. Energy companies came under pressure as crude oil futures cratered more than 4% to three-month lows because of worries about excess supplies.

The S&P 500® Index (INDEXSP: .INX) posted its highest close since April 2022, settling well above 4,300, though market breadth remained unimpressive amid continued leadership from info tech. Cyclical sectors like materials and financials lagged.

Volatility often declines when stocks rise, but that wasn’t the case yesterday. The Cboe Volatility Index® VIX–sometimes referred to as the market’s “fear gauge,”—rose sharply to above 15 from three-year lows last week near 13.5. This could reflect investor caution ahead of this week’s data and Fed meeting. Some veteran market observers say a higher VIX accompanied by a rallying stock market could signal weakness ahead. Trading might be a bit stagnant, however, until the Fed’s rate decision tomorrow afternoon.

Morning rush

• The 10-year Treasury note yield (TNX) fell 7 basis points to 3.68% after the CPI report.
• The U.S. Dollar Index ($DXY) eased to 103.11.
• The Cboe Volatility Index® (VIX) futures fell to 14.59 after the CPI data.
• WTI Crude Oil (/CL) climbed to $68.65 per barrel.

Just in

Though today’s May CPI report showed signs of progress, the 4% annual rate is well above the Fed’s 2% goal, meaning there’s no guarantee that rate hikes are over. The 4% level represents improvement from 4.9% in April. Headline CPI of 0.1% also improved from 0.4% a month earlier, but the headline number is subject to volatile food and energy prices.

Core CPI of 5.3% annually remains high but was down from 5.5% in April. The core number indicates the Fed might still have work to do bringing down the price of services, which continue to drive inflation. Shelter and used car and truck prices remain hot on the inflation meter.

Eye on the Fed

Chances of a pause to interest rate hikes at this week’s FOMC meeting stand at 97% this morning, up from around 79% earlier this week, according to the CME FedWatch tool, which also prices in a 67% chance that rates will rise by July. Probabilities of a rate pause climbed sharply after the CPI data, but the chance of another hike in July stayed practically unchanged.

• While today’s CPI and tomorrow’s Producer Price Index (PPI) data could work into the mix, the Fed has sent strong signals it intends to pause, and the market seems relatively confident of that. A pause doesn’t necessarily mean rate hikes are over after 10 consecutive increases since March 2022. The market appears to approach this as a “skip,” allowing the Fed an extra six weeks to monitor the economy with the benchmark borrowing rate at its current range between 5% and 5.25%.
• To hammer home the Fed’s willingness to hike in the future, Fed Chairman Jerome Powell may adopt a hawkish tone in his press conference tomorrow after the 2 p.m. ET rate decision and statement tomorrow. Stocks have rallied to nine-month highs in part out of hopes for a pause, and Powell likely will want to keep expectations in check.
• Inflation remains well above the Fed’s 2% goal. With unemployment under 4% despite all the rate hikes, FOMC policymakers may not be as worried about the possible labor market impacts of further increases. In fact, they’re still trying to slow down jobs growth to fight inflation.
• Tomorrow afternoon’s meeting wrap-up includes the central bank’s latest projections for economic growth, unemployment, and inflation. It also brings the Fed’s updated dot-plot, providing estimates for the future path of rates. Many analysts expect the Fed’s current terminal, or peak, rate for 2023 to rise about 25 basis points from the current 5% to 5.25%.
• The Fed isn’t the only central bank meeting this week. The European Central Bank (ECB) is expected to issue a rate decision Thursday followed by the Bank of Japan (BoJ) on Friday. Analysts predict the ECB will raise rates by 25 basis points and the BoJ will maintain its current stance. This and the recent rate hikes by the central banks of Canada and Australia underscore that central banks are no longer moving in unison. The ECB’s inflation concerns haven’t cooled, but Japan’s central bank might welcome a little inflation after decades of stagnant prices.

What to Watch

Today’s CPI is followed closely by the PPI at 8:30 a.m. ET Wednesday and May Retail Sales on Thursday.

Producer prices: Recently, PPI has fallen to milder levels than CPI, a positive sign if it means companies can pass along their savings to customers by not raising prices so quickly. In April, both PPI and core PPI rose 0.2%.

Consensus among analysts for Wednesday’s May PPI, according to Trading Economics:

• PPI: -0.1% month-over-month
• Core PPI: +0.2% month-over-month
• Annual PPI: +1.5%, down from 2.3% in April
• Annual core PPI: +2.9%, down from 3.2% in April

Stocks in the Spotlight

Up in the cloud: Oracle ORCL shares got an upward jolt late Monday after the software company beat Wall Street’s earnings and cloud growth estimates for the quarter. Guidance also looked solid. Total cloud revenue climbed 54%, above Oracle’s guidance of 49% to 51%. The company also emphasized its cloud offering as a prime choice for generative artificial intelligence (AI). In addition, the earnings press release highlighted Oracle’s partnership with semiconductor firm Nvidia NVDA. Like many other cloud-related stocks, Oracle shares shined in the first half of the year.

Bond break: Bond market volatility soared in the first half of 2023, so what can you expect in the second half? Check out the mid-year Outlook on Fixed Income from Kathy Jones, Schwab’s chief fixed income strategist. 

CHART OF THE DAY: SEPARATE WAYS. The S&P 500 index (SPX—candlesticks) and crude oil (/CL—purple line) have gone the exact opposite direction this year, with the SPX up 13% and crude down 17%. High crude prices were one factor weighing on stocks last year. Data sources: S&P Dow Jones Indices, CME Group. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

I beg to differ: Headlines early this week focused on divergent predictions from two major U.S. bank analysts. One believes earnings could plunge in the second half of 2023 and send the SPX back below 4,000; the other predicts an extended Wall Street rally. The bearish analyst expects S&P 500 earnings per share to fall to $189 in 2023 from around $219 in 2022. While many Wall Street analysts expect year-over-year earnings to decline in the current Q2, the average estimate also has EPS rebounding in the second half and finishing slightly above 2022 levels for the full year, according to FactSet. Although only one quarter of 2023 earnings is under the market’s belt, even a 6% EPS drop in Q2 would have S&P 500 earnings per share close to $100 for the first half, meaning it would have to be an extraordinarily poor second half of corporate earnings for the bearish analyst to be correct. The other, more bullish bank analyst forecast the SPX to finish 2023 near 4,500. It’s not uncommon for analysts to differ, and these two might be outliers with their forecasts for dramatic strength or weakness in months to come.

Valuation evaluation: Speaking of earnings, keep in mind that the SPX now has a forward price-earnings (P/E) ratio of 18.5, according to FactSet. That’s well above the 10-year average of 17.3 and above the 18.1 it was at on March 31, but below levels reached at the market’s peak in early 2022. Sometimes, though not always, a higher-than-normal P/E can slow market rallies. Analysts expect S&P 500 earnings to rise just 2.4% this year, but 12.3% in 2024, FactSet says. The strength in P/E suggests investors might be starting to look past what many expect to be lackluster 2023 earnings and toward 2024, when earnings could gain a tailwind from easier comparisons and what many participants hope will be a more dovish Fed. Tomorrow’s Fed economic projections and rate dot-plot might play into where 2024 earnings expectations head from here.

IPO sighting: In what’s been a sluggish year for initial public offerings (IPOs), things speed up slightly this week thanks to a scheduled IPO from restaurant chain Cava Group (CAVA). The company on Monday raised the expected price of its IPO to between $19 and $20 a share from the previous $17 to 19, according to MarketWatch. Trading is expected to begin Thursday. In a CNBC interview Monday morning, Goldman Sachs (GS) CEO David Solomon called the IPO market “anemic” this year but expressed hopes for improvement in 2024. That could certainly be helpful for GS and other banks with large capital markets businesses hurt by the dried-up IPO environment. Less than $7 billion has been raised in IPOs this year through mid-May, according to Renaissance Capital, as high interest rates continue to suppress offerings. The 2021 U.S. IPO market reached $142 billion in a monster year, but even average years in the last decade typically brought about $50 billion worth of IPOs.

Calendar

June 14: FOMC rate decision, May Producer Price Index (PPI), and expected earnings from Lennar (LEN).

June 15: May Retail Sales, May Industrial Production, June Empire State Manufacturing, and expected earnings from Kroger (KR).

June 16: Preliminary June University of Michigan Consumer Sentiment.

June 19: Markets closed for Juneteenth, a U.S. federal holiday.

June 20: May Housing Starts and Building Permits.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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