July 11, 2023
Tomorrow’s June CPI report is an important catalyst for markets with consensus looking for a headline number of +3.2%, down from +4% in May. The most bearish outcome for equity markets would be a headline print north of +3.7%. We’ve assigned a 5% probability to this outcome with the SPX trading down ~2.5% as a result. Something in the 3.3%-3.6% range gets a 15% probability with ~1% downside in the SPX. We’ve assigned a 45% probability to a headline print in the 3.0%-3.2% range, which should result in upside in the +50bp-75bp range. We see 25% probability of a headline number in the 2.8%-2.9% range, resulting in estimated upside of ~1.5%. A print below 2.7% gets a 10% probability with the SPX adding ~2.5% to test the upper end of technical resistance near 4535. Anything at 3.2% or lower should result in continued equity upside, improved market breadth, and cyclical sector leadership.
Yesterday’s sharp drop in the Manheim Used Vehicle Index should provide some cushion to a surprisingly hawkish CPI outcome. The Manheim Used Vehicle Index has declined more than 9% since March, while the Used Cars and Trucks component of CPI has increased more than 9% since February. Note that Used Cars and Trucks represents ~12% of core goods CPI inflation. A more hawkish CPI print that includes used car price inflation would be partially dismissed based on known lags between real-time inflation measures and official government statistics.
The Fed is still expected to hike in July, but an inline or dovish June CPI outcome would signal an end to the tightening cycle. Equity markets have reacted very positively to the end of past hiking cycles with outperformance from Financials, Industrials and Materials sectors in that order. Fixed Income markets have also reacted favorably to the end of hiking cycles with a peak in yields occurring 1-2 months before the end. The next Fed policy decision after July will occur on September 20. If you assume a July rate hike is the last of this cycle, the ultimate ‘end’ of the cycle would be September 20, and yields should be peaking within a matter of weeks.