Industrial Investment: CPI leading indicator boosts market sentiment! Analysts: unlikely to deviate significantly from expectations

The Federal Reserve expects further interest rate hikes this year, which limits the rebound in U.S. stocks in 2023, butIf Wednesday's CPI falls faster than expected, the outlook for interest rates and the stock market could change again.

According to a Wall Street Journal survey, economists expect headline inflation to fall from 4.0% to 3.1%, and core inflation to fall from 5.3% to 5.0%.

Analysts said Wednesday's CPI report is expected to be positive, thus driving Tuesday's rally in U.S. stocks. Fundstrat analyst Tom Lee predicted this week that the S & P 500 will rise 100 points (2.3%) this week and that inflation will fall faster than expected. Lee's reasoning is simple:

Lower inflation has eased the pressure on the Federal Reserve to continue raising interest rates, potentially causing the Fed to move more quickly to lower rates, or at least not push them too high.

Jason Drajo, head of asset allocation for the Americas at UBS Global Wealth Management, described the impact of the sudden drop in inflation on the market in emailed comments. He said:

"The headline and core CPI are expected to fall sharply in June, and the three-month annualized core is likely to fall to 2%... If this level persists for a few more months, enough investors will be convinced that the inflation problem is'solved '. There will also be no good reason for the Fed to keep interest rates high for an extended period of time, thereby reducing the risk of recession."

In trying to predict what might happen, analysts have focused on leading indicators such as the Mannheim Used Car Index, which is popular on Wall Street as a reliable inflation forecasting tool.

The Mannheim used-car index, released on Tuesday, showed that used-car prices fell 10.3 percent over the past year, the tenth straight month of declines and the steepest decline since June, leading more analysts to believe the CPI would fall even faster.

Goldman Sachs Group Chief Economist Jan Hatzius said in a note to clients that the core CPI is likely to record 0.2% this month, below market expectations, and pointed to falling used car prices as one of the reasons for his downward revision.

He said in his report:

"We expect core CPI inflation to remain in the 0.2-0.3 per cent range on average over the next few months. This reflects continued moderation in housing inflation, lower used car prices and slower non-housing services inflation as labour demand continues to moderate."

Of course, some argue that the usefulness of the Mannheim index has waned. Brent Donnelly of Spectra Markets says that between 2020 and 2022, the Mannheim index becomes a reliable predictor of core inflation, as price pressures start to rise after little inflation over the past decade. However,As inflation has fallen from its highest level in more than four decades since last summer, its reliability is beginning to wane.

Donnelly said that since the beginning of this year,Economists' median forecasts for inflation have been fairly accurate, reducing the likelihood that they will be much lower than expected.

So far this week, US stocks appear to be on the mend. The S & P 500, Nasdaq and Dow all closed higher on Tuesday, according to FactSet, partly on better expectations for the inflation report. But markets have been a bit turbulent recently, with the S & P 500 falling in two of the past three weeks, according to FactSet, after five straight weeks of gains, its longest streak of gains since late 2021.