Why tomorrow could be a big day for the stock market

At the start of each month, the U.S. Bureau of Labor Statistics (BLS) releases the latest Consumer Price Index (CPI) data, a benchmark that tracks price changes for a wide range of goods and services that people use every day. Investors are watching the CPI to gauge the current state of inflation, which has hit a 40-year high for most of the year and prompted aggressive interest rate hikes by the Federal Reserve. , which is trying to curb the high prices currently plaguing the country.

On Wednesday, the BLS will release July CPI trend data. It has the potential to move the markets in a big way. Here’s why.

Has inflation peaked?

Inflation has been a real headache for the market this year, leading to a huge sell-off in stocks. The first six months of the year ended up being the worst market open half in 50 years. After two years of sluggish economic activity and rising savings, consumer demand has exploded in 2022, driving up the prices of almost everything. Supply chain issues and the huge amount of cash injected into the economy by the Fed in recent years have only made the storm worse.

With stock valuations high, stock prices were crushed after the Fed indicated it would aggressively raise its benchmark overnight lending rate, the federal funds rate, to slow the burning economy. The Fed’s response led the market to believe that some recession was almost inevitable. The first half of the year included two consecutive quarters of negative gross domestic product (GDP) growth, marking what many consider a technical recession.

The Fed has now raised the federal funds rate from a range of 225 basis points (2.25%) to 250 basis points since March, and investors are starting to wonder if inflation has already peaked. So far, the CPI hasn’t shown it. Economists expected the CPI to rise 8.8% in June on an annual basis. The CPI surprised the market by rising 9.1%, meaning prices continued to rise.

Data by YCharts.

But the market seemed to find some relief in the new data, as much of the increase was due to energy and gasoline prices, which fell back in July, suggesting that inflation may have to be peaked. Sentiment was further picked up when, following the Fed’s July meeting, Fed Chairman Jerome Powell said the Fed might be able to slow the pace of rate hikes later this year. , but that would depend on the data.

This makes the CPI reading for July particularly important, as it could be an indicator of how aggressively the Fed will act with rate hikes for the rest of the year. As such, Wednesday’s CPI reading is likely to move markets strongly one way or the other.

What to look for

Investors typically look for data that shows inflation has peaked, leading the Fed to slow its aggressive bid to rein in rising prices, which then makes it less likely that the Fed will tip the economy into a tailspin. severe recession.

Typically, that would mean a CPI reading for July at or below economists’ forecast of 8.7% year-on-year growth in July. The 8.7% forecast would mark a slowdown from June, but the devil is in the details.

At this point, given the drop in energy and fuel costs in July, investors are likely expecting to see some reduction in overall CPI growth. But if other consumer prices, such as those associated with food, transportation and rent, remain high or rise, investors may still worry about persistently high inflation and continued inflation. the Fed’s aggressive policy. Ideally, the market will want to see some price softening related to other categories outside of energy to really drive stocks higher. But it’s also possible that the market is simply looking to confirm that inflation took a break in July.

And then, of course, if the CPI is above the projection of 8.7%, markets could struggle, especially given lower energy costs. But investors should be aware that predicting market reaction is difficult even though it seems logical at this time. Just be prepared to see some movement on Wednesday and don’t try to trade around this short-term event. Stick to stocks that have good long-term prospects and be patient.

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