Why Wednesday’s U.S. inflation report could ignite stock-market volatility as investors boost bets on Fed’s rate cuts

The April consumer price index reading from the Bureau of Labor Statistics, which tracks changes in the prices paid for goods and services, is expected to show a 0.4% monthly increase and a 5% rise from a year earlier, according to a survey of economists by Dow Jones. That would be a sharp rise from the 0.1% month-over-month gain in March, which was the smallest increase in two years. 

The core price measure that strips out volatile food and fuel costs, is expected to rise 0.3% from the previous month, or 5.4% year over year. 

“We expect another rough inflation print in the April CPI report, with a sequential jump in the headline and little to no month-on-month improvement in the core,” said a team of economists led by Carl Riccadonna, chief U.S. economist at BNP Paribas. 

However, the details in the April report could provide a “slightly more optimistic signal,” said Riccadonna in a Monday note. His team is expected to see further moderation in non-housing services costs, which is the most important inflation component for the Fed, but they also expect a rebound in used car prices to drive the strong headline and core prints. 

Prices of used vehicles, an early contributor to the runup in U.S. inflation, fell in March for the fifth month in a row, government data shows.

“Fed officials will likely be wary in acknowledging progress on the inflation front, so as not to be caught off-sides by yet another false dawn. Policymakers will likely need to see several more months of sustained improvement before they begin softening their inflation assessment,” wrote Riccadonna and his team. 

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After the Fed’s decision and Jerome Powell’s news conference last week, stock-market investors seem confident that the 25-basis-point rate hike was the last one in the central bank’s interest-rate hiking campaign. Fed funds futures traders priced in a 83.4% probability that policymakers will make no change at their June meeting, while also factoring in the prospect of at least two or three rate cuts by year-end, according to the CME FedWatch Tool. 

What concerns investors is that inflation is only slowly retreating from the 40-year high seen in the past year which makes it too early for the Fed to change its policy. Chair Powell said in his press conference last week that the process of getting inflation back down to 2% “has a long way to go,” while reiterating that future data will determine whether more interest rate increases are needed. 

Michael Kramer, founder of Mott Capital Management, thinks the CPI report on Wednesday will likely create “a lot of volatility in markets before and after the data release.”

“The reason is that now the Fed is going to be data dependent, which means hot data will drive more rate hikes… This will increase overall market volatility heading into the June FOMC meeting,” he wrote in a Sunday note.

Melissa Brown, managing director of applied research at Qontigo, said a hotter-than-expected inflation print may not necessarily indicate more rate hikes ahead, but it certainly suggests the central bank is not going to cut rates any sooner. 

“Inflation numbers are going to be really important to confirming or denying what the market seems to be thinking,” she told MarketWatch in a phone interview on Tuesday. “[If] CPI report comes in lower than it has been, that would probably be good news – it would confirm that the Fed doesn’t need to increase rates anymore.”

“If the number is high… it certainly does suggest that even if the Fed doesn’t continue to increase rates, they’re certainly not going to cut rates.” 

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Meanwhile, still-high inflation could pressure corporate earnings further as the rising cost of fuel, materials and wages point to downward trends in earnings-per-share and margins, said Brown. 

“So far with the first quarter earnings, it doesn’t seem that there is a huge impact… but it obviously remains to be seen whether that starts to happen in the second quarter, because we are starting to hear things about costs going up,” she said.

Adding to the volatility concern is the light trading volume ahead of Wednesday’s CPI report, which shows “a lack of conviction” in the stock market, said Brown. U.S. stocks finished modestly lower in quiet trading on Tuesday. The Dow Jones Industrial Average
DJIA,
-0.66%
lost 0.2%, while the S&P 500
SPX,
-0.17%
dropped 0.5% and the Nasdaq Composite
COMP,
+0.18%
shed 0.6%. 

However, it is worth noting that the CPI report has gradually become less significant to the market over the past few months as the rate of change continues to diminish, noted Kramer. 

CPI data publication days have been among the most volatile for stocks over the past year as price pressures have become investors and the Fed’s chief concern. In 2022, the S&P 500 recorded both its biggest daily gain and its biggest daily loss on the day that monthly CPI data were released, according to Dow Jones Market Data. 

“However, the April report holds some importance, as year-over-year comparables are forecast to ease between now and July,” Kramer said. “Any deviation in the data could devastate those expecting inflation to return to the Fed’s target soon.”