US CPI Preview: Are Stocks OK with a Longer Fed Rate Cut Delay?

The May US CPI is expected to show headline inflation rising to 2.5% year-on-year, with core inflation, the Fed's focus, potentially reaching a three-month high of 2.9%. Recent PPI and PMI data suggest rising prices are in the pipeline, particularly in the service sector, reinforcing expectations that the Federal Reserve will likely maintain its current stance on interest rates, despite market expectations of potential rate cuts later in the year as economic growth concerns outweigh inflation risks.

Analysis

Financial markets are currently characterized by low trading volumes, as indicated by the S&P 500 futures posting their lowest volume day since January 9 and similar subdued activity in 30-year Treasury bond futures, with market participants keenly awaiting the May US Consumer Price Index (CPI) data as a potential catalyst. Expectations for the May CPI report include an acceleration in headline inflation to 2.5% year-on-year from April's 2.3%, and, critically for Federal Reserve officials, a rise in the core CPI measure (excluding volatile food and energy) to 2.9%, which would be a three-month high. While April's CPI figures were perceived as relatively 'normal,' subsequent Producer Price Index (PPI) data suggested businesses absorbed higher input costs to shield consumers. Furthermore, recent Purchasing Managers Index (PMI) surveys from S&P Global and the Institute for Supply Management (ISM) have pointed to rising price pressures in the pipeline, with the ISM figures notably revealing the fastest service sector price growth since November 2022. This service sector metric has historically lagged headline inflation gauges like CPI and PCE by approximately two months, suggesting potential for reflation in the coming months. This outlook seems to reinforce the view that the US central bank will not be hastened into cutting interest rates, despite current market pricing factoring in at least one 25-basis-point cut by October and a 56% probability of a second by year-end. Contradictorily, inflation expectations priced into bond markets ('breakeven rates') have trended lower, suggesting that concerns about recessionary forces may be outweighing reflation risks for some market participants. Should the upcoming CPI data provide the Federal Reserve with another reason to remain on hold, it could dampen risk appetite, potentially leading to downside for equities (SPY sentiment: -0.4), while gold prices (GLD sentiment: +0.5) may rise alongside long-end bonds, and the US dollar (UUP sentiment: -0.5) could weaken if speculators anticipate that a delay in rate cuts now will translate to sharper easing later.

Key Decisions for Investors

• Investors should closely monitor the upcoming May US CPI data, as figures showing persistent inflation, particularly core CPI reaching the expected 2.9%, could lead the Federal Reserve to delay anticipated rate cuts, thereby impacting risk assets.
• A scenario where CPI data reinforces Fed caution, as discussed in the article, may exert downward pressure on equities (SPY sentiment: -0.4) while potentially benefiting assets like gold (GLD sentiment: +0.5) and long-duration Treasury bonds.
• Evaluate positions in the US dollar (UUP sentiment: -0.5), as a delay in Fed rate cuts due to strong inflation could lead speculators to anticipate more aggressive easing later, potentially resulting in dollar weakness over the medium term.