Signs of Progress: Market Builds On Gains After June Inflation Growth Undercuts Expectations

(Wednesday market open) Comforting news on U.S. inflation provided Wall Street an early lift this morning, but expectations for a rate hike later this month remain extremely high.

U.S. core consumer inflation growth slowed to 0.2% in June, below analysts’ 0.3% expectations and down from 0.4% in May. Headline inflation of 0.2% was also better than the expected 0.3% but up from 0.1% the prior month. As a reminder, core inflation is the more important reading to watch, as it excludes volatile food and energy costs.

The June Consumer Price Index (CPI) report was better than expected across the board, and it could provide another boost to the bullish inflation deceleration narrative. Core inflation slid to 4.8% on an annual basis from 5.3% the prior month, when analysts had expected 5% or above. The core data has been “stickier” than headline, so the drop this time out could get some attention.

While the market had rallied into the data amid anticipation of a bullish outcome, the immediate positive reaction by stock index futures suggested that the data was even better than market participants had expected.

Yesterday’s action on Wall Street reflected high spirits ahead of the CPI data. Energy stocks led gainers as crude oil (/CL) hit two-month highs thanks to recent production cuts by Russia and Saudi Arabia. Over the last week, energy’s been one of the best performing sectors, along with industrials and financials. The broader market is down, reflecting in part weakness in the mega-cap info tech stocks. They’ve hit some resistance recently after their long rally.

Morning rush

• The 10-year Treasury note yield (TNX) descended 7 basis points to 3.9% after the CPI report.
• The U.S. Dollar Index ($DXY) dropped to 101.14, near a three-month low.
• Cboe Volatility Index® (VIX) futures fell sharply to 14.06 after the CPI data.
• WTI Crude Oil (/CL) jumped to $75.43 per barrel.

With /CL prices climbing sharply early this week, focus turns today to the weekly U.S. Crude Inventory data due out at 10:30 a.m. ET. Inventories dropped 1.5 million barrels in the previous report.

Just in

The major indexes built on earlier gains after the CPI report, though expectations of a Federal Reserve rate hike later this month didn’t shift much. Perhaps that’s because the Fed’s preferred inflation metric isn’t CPI but the Personal Consumption Expenditures (PCE) core services ex-housing data, which has been mired in the 4.6% to 4.7% range over the last several months. An update is due on July 28 after the next Fed meeting. The Fed’s inflation target is 2%.

Consensus for CPI had been +0.3% month-over-month for both headline and core, and 3.1% and 5%, respectively, for year-over-year headline and core, according to Trading Economics.

Stay tuned for the June Producer Price Index (PPI) tomorrow morning (more below).

Overnight, Japan reported a -0.2% monthly PPI, lower than analysts had expected.

Eye on the Fed

Futures trading indicates a close to 90% probability that the Federal Open Market Committee (FOMC) will raise interest rates by 25 basis points at its July 25–26 meeting, according to the CME FedWatch Tool. That’s down slightly from 95% earlier this week. However, the market is coalescing behind the idea that a hike this month will be followed by a pause in September. Chances of a follow-up September hike fell to 10% this morning from above 20% last week, and the market prices in nearly a 60% probability that the July hike will be the last of the year.

The Fed will publish its Beige Book on economic conditions around the country this afternoon, and on Thursday evening Fed Gov. Christopher Waller will deliver a speech on the economic outlook.

The Beige Book is properly titled, considering it makes a rather dry read. Those willing to plow in may recall that the May Beige Book reported “little change” in overall economic activity across the Fed’s 12 Districts but widespread expectations for a further expansion in activity. One thing the last Beige Book highlighted was strong consumer spending, especially in leisure and hospitality, even as manufacturing and transportation demand remained light. The report could provide new insight into whether consumers continued to flock to hotels, restaurants, and casinos in June.

Deeper in the Beige Book, check for any references to potential problems in the private credit markets. Bankruptcy filings appear to be picking up and banks are tightening lending, says Kathy Jones, Schwab’s chief fixed income strategist. That could trigger a potential credit crunch that causes spreads in the public markets, like high yield, to widen.

What to Watch

PPI time: The June PPI is the next major data point, due out at 8:30 a.m. ET Thursday.

Consensus for PPI, according to Trading Economics, is:

• June PPI: +0.2% versus -0.3% in May
• June Core PPI: +0.2% versus +0.2% in May
• June annual PPI: +0.4%, versus 1.1% in May
• June annual core PPI: +2.6%, versus 2.8% in May

PPI is often seen as a predictive report, though there’s no guarantee. The idea is that companies enjoying softer wholesale price growth could pass savings on to customers. However, yesterday’s news that Salesforce (CRM) would hike prices across its cloud-based offerings starting next month continues a long trend of companies raising, not lowering, prices.

This earnings season it’ll be interesting to hear whether executives across all sectors believe customers can handle higher prices. That proved a theme in Q1 earnings season. Continuation into Q2 might imply elastic demand that allows companies to raise their profit and revenue outlooks.

Stocks in Spotlight

Snack time: When PepsiCo PEP last reported in mid-April, it noted crunchy demand for popular products like Lay’s and Doritos. Shares rose sharply after the announcement but ran out of steam in May and June. They remain near three-year highs, however. PepsiCo reports tomorrow morning, and guidance will be in focus after the company raised its outlook last time. For the recently ended quarter, analysts expect revenue of $21.7 billion and earnings per share (EPS) of $1.95, according to Earnings Whispers.

Delta Airlines DAL is another company to watch first thing tomorrow, with analysts expecting EPS of $2.42 and revenue of $14.43 billion, Earnings Whispers says. The company already delivered a bullish preview late last month, predicting a solid summer travel season and the highest Q2 earnings in its history.

UnitedHealth UNH reports Friday morning. It’s been a tough year so far for its investors. Shares haven’t participated in the 2023 market rally, instead heading down about 15% since the end of last year. Higher costs hit both UnitedHealth and competitor Humana HUM as people—especially seniors—started catching up on surgeries they’d put off during the COVID-19 pandemic, Barron’s reported last month. UnitedHealth CEO Tim Noel spoke positively of the trend at last month’s Goldman Sachs Global Healthcare Conference, saying he’s happy to see seniors accessing the care they need.

Talking technicals: The S&P 500® Index (SPX) continues to bob along below 4,450, which is near the high close for the year reached July 3. The old 4,325 resistance mark from the August 2022 high looks like potential support. One resistance point might be near 4,530, which marks a Fibonacci retracement level. Above that is significant resistance near 4,600. This is the level where the index ran into selling pressure twice in February 2022 and again in March 2022.

CHART OF THE DAY:  RANGE LIFE? The S&P 500 Index (SPX—candlesticks) may be forming a new trading range after surpassing the summer 2022 highs last month. The range could arguably be between the 4,325 level (bottom red line) where last summer’s rally stalled and 4,600 (top red line) where the index ran into selling pressure back in early 2022, as this two-year chart shows. The bottom of this particular range also happens to also align with the 50-day moving average, which is creeping toward 4,300. Data source: S&P Dow Jones Indices.Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

Rainy day fund: When several big banks report Friday, eyes might turn toward a couple of metrics in the quarterly data. First, how much extra money will these companies put aside for protection against possible loan defaults, sometimes known as “loan loss” provisions? Most large banking institutions added to these piles of cash in their previous quarters amid worries about credit conditions after several banks failed and commercial real estate looked increasingly worrisome. If the big banks set aside less this time or decide they’ve built up enough already, it could be a positive signal that they’re comfortable with the credit market. If they add more, it could slice away earnings power and hint that we’re far from done with credit issues.

Banks and employment: Another key metric to watch when big banks report and when smaller banks start next week is deposits. Customers at smaller banks got rattled by instability in Q1 following Silicon Valley Bank’s (SVB) failure. That led many to move deposits to bigger banks. The question is whether that continued in Q2, and if so, what it might mean for smaller banks and their future lending abilities. Remember, small businesses often lean heavily on small banks for loans, and small businesses employ nearly half of all U.S. workers, according to Forbes. If the banks that small businesses rely on continue to struggle, small businesses might also struggle to grow, perhaps undercutting the strong employment picture.

Defense on field: When Lockheed Martin (LMT) reports next Tuesday, international relations could be part of the curriculum. Just hours after Turkey agreed on Monday to allow Sweden into NATO, the United States announced it’s moving ahead with the transfer of F-16s to Turkey, Reuters reported. The $20 billion sale of those Lockheed planes has been held up since 2021, and it still needs congressional approval. Even if this deal goes through, the yearslong tension between Turkey and the U.S. could mean this transaction is a one-off. A related question is whether the United States would consider allowing Turkey back into its F-35 manufacturing program. The F-35 is also built by Lockheed, with partners Northrop Grumman (NOC) and BAE Systems PLC. The United States dismissed Turkey from the F-35 program in 2019 when Turkey acquired a missile defense system from Russia. Some military analysts told the media they don’t think Turkey will be allowed to buy the F-35 if that defense system is in place. The unit cost of an F-35 starts near $75 million, according to Air & Space Forces Magazine, while the F-16 is somewhat cheaper. Aeronautics is by far Lockheed’s biggest business in terms of revenue. Shares of Northrop Grumman and Lockheed both rose on Tuesday but are lower year-to-date.

Calendar

July 13: June Producer Price Index (PPI) and expected earnings from Conagra (CAG), Delta Airlines (DAL), and PepsiCo (PEP)

July 14: University of Michigan July Preliminary Consumer Sentiment and expected earnings from JPMorgan Chase (JPM), Citigroup (C), Wells Fargo (WFC), and UnitedHealth (UNH)

July 17: July Empire State Manufacturing

July 18: June Retail Sales and expected earnings from Bank of America (BAC), Morgan Stanley (MS), Lockheed Martin (LMT), and PNC (PNC)

July 19: June Housing Starts and Building Permits, and expected earnings from Goldman Sachs (GS), First Horizon (FHN), Haliburton (HAL), and U.S. Bancorp (USB)

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

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