Stock market could suffer 'ugly' day if April CPI comes in above this level

By William Watts

Core reading in focus as investors weigh Fed's next interest-rate move

A May rally has taken the stock market back to the cusp of record territory after last month's pullback - and April inflation data due out Wednesday is widely considered a potential catalyst for either new highs or a renewed slide.

Tom Essaye, founder of Sevens Report Research, took a look Tuesday at potential "good, bad and ugly" outcomes for the April consumer-price index reading.

Here's the setup: Rates traders came into 2024 expecting the Federal Reserve to deliver six, or possibly more, quarter-point interest-rate cuts before the end of the year. But a series of hotter-than-expected CPI reports, plus other inflation measures, saw those expectations shrink - with traders now penciling in around a pair of cuts this year.

Stocks largely took it all in stride, but fell back in April. Equities bounced back after Fed Chair Jerome Powell on May 1 told reporters that a rate hike was unlikely to be the central bank's next move.

The S&P 500 SPX is up more than 9% in the year to date, finishing Monday just 0.6% below its record close of 5,254.35 points, set on March 28. The Dow Jones Industrial Average DJIA remains less than 600 points away from the 40,000 milestone, while the Nasdaq Composite COMP has advanced more than 9% so far in 2024.

Whether investors remain calm about the interest-rate outlook could come down to the April reading. Economists surveyed by the Wall Street Journal, on average, look for April CPI to show a 0.4% monthly rise, which would see the year-over-year rate slow to 3.4%, from 3.5% in March.

Core CPI, which strips out food and energy, is estimated to show a 0.3% monthly rise, slowing to 3.6% year over year from 3.8% in March. The core reading, which is more closely watched by policy makers, will likely be the key to the market's reaction.

Ugly

So what would provoke an ugly reaction? Essaye puts the threshold at 3.9%.

A core reading at or above that threshold would be likely to spark a "solid selloff," further entrenching the idea that inflation remains sticky and rates will be higher for longer, Essaye wrote. That has the potential of undoing much of the rally seen over the last two weeks, as investors would likely scale back rate-cut expectations, penciling in just one cut in December.

A fall of 1% or more by the S&P 500 wouldn't be a surprise, with all sectors likely to decline, he said, though defensive plays would likely outperform. That would also likely spark a jump of 10 to 15 basis points in the 10-year Treasury yield BX:TMUBMUSD10Y, which would help propel the ICE U.S. Dollar Index DXY above 106.

Not so great

An above-consensus core reading of 3.7% to 3.8% year over year would be unlikely to spark as violent a reaction, but would still likely see stocks fall and Treasury yields, which move opposite to bond price, rise.

Such a minimal decline in inflation wouldn't put to rest worries that price pressures remain sticky, Essaye said. It would be likely to prompt a "mild selloff," with "supercap" tech and cyclicals able to outperform while defensive plays lag.

Good times

A year-over-year core reading at or below the consensus 3.6% level would be a recipe for relief, Essaye said, implying a renewed decline in core inflation. In such a scenario, "new highs shouldn't be a surprise," with stocks extending their bounce off of April's lows and led by the "rest" of the market outside the "supercap" tech names.

It would also likely prompt a sharp fall in Treasury yields, with the 10-year potentially falling below 4.4% and toward the 3.75% to 4.25% range it saw earlier this year, Essaye said. The dollar index would also likely come under pressure as investors price in two to three 2024 rate cuts.

-William Watts

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05-14-24 1322ET

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