Powell is most likely to "show his cards" at this time!

Fed Chairman Powell this week made a significant hint about the Fed's plan to end its longest period of tightening policy on record, but this hint has nothing to do with the inflation path.

For most of the past four months, the U.S. stock market has been rising, hitting a series of record highs and expanding the S&P 500 index's gain to around 17% so far this year. These exciting returns are built on the huge profits of large tech companies, improving corporate earnings, and bets on the Fed's rate cuts in the fall.

In the post-COVID era, U.S. inflation has soared, and the Fed has raised its benchmark interest rate to around 5.375%, the highest level in 22 years. The last rate hike was nearly a year ago when the overall inflation rate was 3.2%.

Since then, inflation pressures have been difficult to control, which is frustrating. In November of last year, the rate peaked at 3.7%, dropping to 3.1% in January this year, both well above the Fed's preferred target of 2%.

Economists expect that the CPI data to be released on Thursday will show a year-on-year increase of 3.1% in overall CPI for June, which is not much different from the previous value; the core price annual growth rate is expected to be 3.4%, roughly the same level as in May.

This may not be enough to signal a rate cut by the Fed in the near term, especially considering the Fed's warning that the so-called base effect may bring slight upward pressure on inflation in the second half of the year.

The Fed's Subtle Shift from Inflation Focus

Fed Chairman Powell cleverly shifted the market's focus from stubborn inflation data to recent weakness in the job market, indicating that this may be a key factor in the Fed's next rate move.

Powell told senators on the Banking Committee on Tuesday, "Rising inflation is not the only risk we face. The latest data shows that the labor market has cooled significantly compared to two years ago."

The U.S. Labor Department reported last week that the U.S. added about 206,000 jobs last month, better than expected, bringing the total employment to about 1.4 million in 2024. However, earlier data was revised downward, and the overall unemployment rate exceeded 4% for the first time in over two years.

Economy Facing Dual Risks

Broader economic growth is also slowing down, with the Atlanta Fed's GDPNow tool showing second-quarter GDP growth of about 1.5%, slightly higher than the 1.3% increase in the first three months of this year.

Considering this slowdown, Powell told lawmakers that the economy faces "dual risks," both of which are related to the Fed's decisions.

Powell said, "If we ease policy too late or too little, we may damage economic activity. If we move too quickly or ease too much, we may disrupt progress on inflation. So, we are largely balancing these two risks."

**This may shift the market's focus to the next round of job market data, including the JOLTS report for June, nonfarm payrolls for July, and Challenger's job cuts data, putting inflation data in the backseat in the coming months **

Economist and Chief Market Strategist Lauren Goodwin from New York Life Investments said:

"After focusing on inflation for two years, the Federal Reserve is now talking more about the labor market and acknowledging that any unexpected weakness in the labor market could prompt them to cut rates faster. But what we are seeing today is not unexpected weakness in the labor market, everything is fine. We believe the earliest the Fed could cut rates is in September, and we believe the Fed will notice the reasons for the shift at that time."

Jackson Hole Central Bank Symposium Could Be Key

The Federal Reserve will hold an FOMC meeting on July 31 and announce the latest interest rate decision. Most market participants expect the Fed to remain on hold, keeping the federal funds rate between 5.25% and 5.5%.

However, the next major event - the Jackson Hole Central Bank Symposium may provide the most clear signal to the market that the Fed may cut rates in September, the CME Group's FedWatch tool shows a 74% probability of a 25 basis point rate cut in September.

At that time, Powell will deliver a keynote speech at this meeting, and he will also have the July employment data and inflation report.

Ian Shepherdson from Pantheon Macroeconomics said, "We still believe that the Fed has waited too long and will soon be eager to prevent a major recession. We expect that at the end of August at the Jackson Hole Central Bank Symposium, Powell will send a clear signal that at least one rate cut is needed this year."

However, this may still disappoint the market as traders expect the Fed to cut rates at least twice this year, with multiple cuts expected in 2025. Rate cuts will support a stock market rebound, pushing the S&P 500 index closer to the 6000 point mark.

After the S&P 500 index hit 36 record highs this year, this could also put the stock market in what Scott Rubner from Goldman Sachs calls a "pullback mode."

Rubner pointed out in a report released this week that stock market flows in August are typically the slowest of the year, and the stock market historically retreats from mid-July highs. If this earnings season disappoints, investors will start focusing on the outcome of the U.S. presidential election.

Generally, a correction is defined as at least a 10% decline. Data from LSEG shows that S&P 500 index component companies' total profits in the second quarter may increase by 10.1% year-on-year to $492.8 billion, about $5 billion lower than previous forecasts. Analysts expect full-year earnings to grow by 10.6%, further increasing by 14.5% in 2025. Rubner said:

"Painful trading has shifted from upward to downward, with buyers fully loaded after the best trading days of the year have passed, and ammunition running low."