Expectations that the Federal Reserve will hike interest rates even more this year have helped contain the upswing in US stocks in 2023, but the outlook for interest rates and, by extension, for stocks could change yet again, when Wednesday’s CPI rise for June shows inflation has fallen faster than economists had expected.
Some analysts are supporting that notion, especially after used car prices, as measured by the Manheim Used Car Index on Tuesday, fell 10.3% over the past year. This is the tenth straight monthly decline and the sharpest since records began in June.
The report caused a stir in the markets, sending shares of troubled used-car sales platform Carvana Co. CVNA up 16% on Monday and another nearly 3% on Tuesday to $36 a share, according to FactSet.
Elevating expectations for Wednesday’s CPI report helped U.S. stocks rise on Tuesday, analysts told MarketWatch.
Expectations that inflation will fall faster than expected played a role in Fundstrat’s Tom Lee’s latest forecast this week for the S&P 500 to gain 100 points, or 2.3%, this week.
See: The S&P 500 could gain 100 points this week on inflation data, says Fundstrat’s Lee
Lee’s reasoning was quite simple: slowing inflation takes the pressure off the Fed to keep raising interest rates, which could potentially allow the central bank to start cutting rates more quickly, or at least not raise rates as high.
Jason Draho, head of asset allocation for the Americas at UBS Global Wealth Management, described in an emailed comment what a sudden drop in inflation could mean for markets.
“Both headline and core CPI for June are expected to fall significantly and three-month extrapolated core metrics could fall to 2%,” he said.
“A few months at this level could convince enough investors that inflation is ‘solved’. If that happens, the Fed will have fewer reasons to keep rates higher for longer, reducing recession risk.”
Economists polled by the Wall Street Journal expect headline inflation to ease to 3.1% yoy from 4.0% and core inflation to slow to 5.0% yoy from 5.3%.
In an attempt to predict what might happen, analysts focus on a handful of leading indicators like the Manheim Used Car Index, which is gaining popularity on Wall Street as a reliable inflation forecaster.
Deutsche Bank’s Jim Reid published a chart illustrating the relationship between the Manheim Index and the used car and truck component of the consumer price index, showing that the latter is very similar to the former.
If this correlation is correct, it could mean that core commodity prices could weigh on the broader inflation gauge in the second half of the year.
Jan Hatzius, chief economist at Goldman Sachs Group, said in a note to clients that he expects core CPI to be below consensus and could come in at 0.2% for the month, citing the drop in used car prices as one of the Reasons for reducing his estimate.
“Looking forward, we expect monthly core CPI inflation to remain at 0.2-0.3%.
The average volatility over the next few months reflects the ongoing slowdown
Inflation in housing, lower used car prices and slower inflation in non-housing services
as demand for labor continues to weaken,” he said in the statement.
Of course, some believe the usefulness of the Manheim Index has already waned. Spectra Markets’ Brent Donnelly showed that Manheim was a reliable predictor of core inflation between 2020 and 2022, when price pressures began to increase after a decade of almost no inflation in the US. However, its reliability began to weaken as inflation cooled from its highest level in more than four decades since last summer.
Year-to-date economists’ average estimates have been fairly accurate in forecasting inflation, Donnelly said, reducing the likelihood of a significant downside surprise.
Investors will find out the exact inflation reading for June at 8:30 am ET on Wednesday, according to the CPI. Meanwhile, the Fed’s favorite PCE price index will be released later this month.
So far this week, US stocks appear to be faring better as the S&P 500 SPX, Nasdaq Composite COMP and Dow Jones Industrial Average DJIA all closed higher on Tuesday, thanks in part to optimism surrounding the inflation report. The S&P 500 was up 0.4% to 4,428 just before the close, according to FactSet data
The markets have been experiencing some turbulence lately. The S&P 500 has fallen in two of the past three weeks after posting five straight weekly gains in what is the longest such winning streak since late 2021, according to FactSet data.