A Double Whammy for the Stock Market This Week After the Fed Announces Its Decision Following the Cpi Inflation Reading

On June 11, stock-market investors are bracing for a potentially tumultuous day, with the May consumer-price index (CPI) set to be released at 8:30 a.m. Eastern, followed by the conclusion of the Federal Reserve’s two-day policy meeting at 2 p.m.

‍

Both CPI and Fed days are known for triggering market volatility. The silver lining for investors is that Fed Chair Jerome Powell will soon offer insights into how central bankers interpret the May inflation data.

‍

It is widely expected that policymakers will maintain current interest rates at the end of the meeting. However, the focus will be on the Fed's outlook for the timing of potential rate cuts, which have been highly anticipated yet elusive.

‍

At the start of 2024, investors anticipated six or seven quarter-point rate cuts beginning in March. However, several unexpectedly high inflation readings and strong jobs reports, including May’s employment data released last Friday, have led fed-funds futures traders to price in a maximum of two cuts, potentially starting in September.

‍

Despite fading expectations for rate cuts, stocks have rallied. Strong economic data has fueled confidence in robust earnings growth for this year and next.

‍

However, this rally concerns some investors, who argue that stocks are now priced for perfection and could be vulnerable to any disappointment.

‍

The S&P 500’s forward 12-month price-to-earnings ratio stands at 20.7, above its five-year average of 19.2 and its 10-year average of 17.8, according to TradeAlgo.

‍

“Equity valuations are expensive today and this really needs to be an earnings growth story going forward,” said Josh Emanuel, chief investment officer at Wilshire, in a phone interview.

‍

There’s little room for error with Wall Street predicting about 25% earnings growth for the S&P 500 over 2024 and 2025, he added.

‍

While the May jobs report caused a selloff in Treasurys, leading to higher yields, equities remained resilient for most of Friday’s session. The S&P 500 and Nasdaq Composite came close to record highs before a late-day pullback resulted in small losses.

‍

Friday’s data revealed that the U.S. created 272,000 new jobs in May, exceeding expectations and suggesting the economy remains robust, which lowers the likelihood of imminent Fed rate cuts. However, the unemployment rate rose to 4% from 3.9%, the highest since January 2022.

‍

Particularly concerning for Fed policymakers, average hourly earnings increased by 4.1% year-over-year, up from 4% in April. The Fed aims for growth closer to 3% to help reduce inflation.

‍

Despite this, the Dow Jones Industrial Average gained 0.3% for the week, while the S&P 500 rose 1.3%, and the Nasdaq advanced 2.4%. Year-to-date, the S&P 500 is up over 12%, with the Nasdaq rising more than 14%. The more cyclical Dow is up just 2.9%.

‍

Technology stocks have dominated 2024, with Nvidia Corp. recently joining the $3 trillion market capitalization club. The S&P 500 equal weight index, which treats all constituents equally, is up just 4.3% this year, highlighting the influence of mega-cap tech stocks.

‍

As the Treasury market adjusted to the jobs data, pushing yields higher, stocks are expected to follow suit, Emanuel noted.

‍

Rising Treasury yields can unsettle stocks, especially if the increase is rapid, as higher yields mean higher borrowing costs and make equities less attractive relative to bonds, which offer more appealing yields.

‍

Emanuel pointed out that while rate markets have responded more logically to economic data and reduced prospects for rate cuts, “equity markets and risk assets have shrugged this off based on the idea that equities will outgrow that valuation headwind coming from higher interest rates.”

‍

Achieving this will be difficult given already strong earnings growth, positive investor sentiment, the absence of recession fears, and increasingly stretched equity exposure in portfolios, he explained. “The setup creates a very challenging environment for equities to outpace expectations.”

‍

Powell might sound more hawkish than anticipated, but the bigger test will come during the next earnings season, when companies must meet rising expectations, he said. Meanwhile, markets may experience increased volatility.

‍

On Wednesday, all eyes will be on the central bank’s policy statement, Powell’s remarks, and an update to the central bank’s Summary of Economic Projections, or "dot plot," which reflects individual policymakers' expectations. Investors will be keen to see how many rate cuts are being considered. The last dot plot from March indicated policymakers expected three quarter-point cuts in 2024.

‍

Antti Ilvonen, senior analyst for U.S. macro at Danske Bank in Copenhagen, commented, “We think Powell is likely to continue downplaying any speculation about further rate hikes, as we see no signs of the economy overheating. Sticky inflation could push cuts further into the future, but current interest rates are still likely seen as restrictive enough. This could again be a dovish signal for markets.”

‍