CPI landing in the market, how will it react? Morgan Stanley predicts that the S&P is most likely to rise by no more than 1%.

On Wednesday, July 12th, US CPI for June will be released in Eastern Time. It is a significant inflation data report published before the monetary policy meeting of the Federal Reserve at the end of this month. Currently, the market generally expects that the year-on-year growth rate of CPI in June will significantly slow down compared to May's 4.0%, and the month-on-month growth rate will be higher than May's 0.1%.

Two major Wall Street institutions, JPMorgan Chase and Goldman Sachs, have made their own predictions on CPI data and the related market reaction.

JPMorgan Chase: The most likely year-on-year growth of CPI in June is between 3.05% and 3.2%

Andrew Tyler, the trader leading JPMorgan Chase's market intelligence team, wrote in the report that this week's CPI is still one of the key catalysts for the summer market. Considering the similarity in the performance of technology stocks and the current market focus on AI and machine learning, many JPMorgan Chase clients are comparing the current situation to the period in 1999. If it is similar to 1999, US stocks will eventually rise after experiencing a summer slump.

Tyler mentioned the Manheim Used Vehicle Value Index released on Monday, which tracks the auction prices of used cars. The index dropped sharply by 4.2% month-on-month in June, the largest decline since the early stages of the pandemic.

Tyler pointed out that the above-mentioned used car index has fallen by 9% since March, but its impact has not yet been reflected in the CPI. In fact, since February, the sub-index for used cars and trucks in the CPI has risen by 9%, with an annualized growth rate of 36% over the past three months. JPMorgan Chase expects that the impact of this index will be reflected in the CPI in the coming months.

Michael Feroli, JPMorgan Chase's chief economist, predicts that CPI in June will increase by 0.3% month-on-month, and the year-on-year growth rate will slow down from May's 4.0% to 3.2%. If the prediction is correct, June's CPI will have the lowest year-on-year growth rate since March 2021, mainly due to base effects. After a significant decline in two out of the past three months, energy prices are expected to rise slightly by 0.3% in June.

Feroli predicts that the core CPI, excluding food and energy, will increase by 0.3% month-on-month in June, and the year-on-year growth rate will slow down from May's 5.3% to 5.0%. If this expectation is met, it will be the first time in six months that the core CPI has a growth rate of less than 0.4%. In June, inflation in the housing sector is expected to continue to gradually cool down, with Owner's Equivalent Rent (OER) rising by 0.51% and rent for tenants rising by 0.52%.

Feroli pointed out that the recent strength in core inflation was due to a surprising 4.4% increase in used car prices in April and May. It is expected that the upward trend in such prices will reverse in June, with a decline of 0.6%.

Andrew Tyler's JPMorgan Chase market intelligence team has predicted various possible outcomes for CPI in June, as well as the potential market reactions after the release of CPI on Wednesday.

• There is a 5% probability that CPI YoY growth will be 3.7% or higher.

If this tail risk scenario occurs, core inflation may rise significantly, and the market will expect a 50 basis point rate hike by the Fed in July, with pricing reflecting expectations of further rate hikes in subsequent meetings. Bond yields and stock market volatility will increase, leading to a sell-off in the stock market, causing the S&P 500 index to fall by 2% to 2.5%.

• There is a 15% probability that CPI YoY growth will be between 3.3% and 3.6%.

If this scenario occurs, the S&P 500 index will decline by 1% to 1.25%. This scenario will not help alleviate market concerns about the end of the rate hike cycle. Due to the base effect, the positive impact of inflation decline is expected to turn into a negative factor, and the bond market may adjust its expectations of rate hikes.

• There is a 45% probability that CPI YoY growth will be between 3.05% and 3.2%.

If this scenario occurs, the S&P 500 index will rise by 0.5% to 0.75%. This result represents a significant slowdown in inflation, which will continue to support the argument for inflation decline. However, it is unlikely to shake the market's expectation of a 25 basis point rate hike by the Fed in July, which should be enough to dispel market expectations of further rate hikes after July.

• There is a 25% probability that CPI YoY growth will be between 2.8% and 2.9%.

If this scenario occurs, the S&P 500 index will rise by 1.5% to 1.75%. This would be the largest slowdown in overall CPI growth during this rate hike cycle. Considering the volatility of PPI and the ISM price index, it may cause the market to adjust its inflation expectations, with inflation expected to remain below 3%. Market expectations for a rate hike in July may decrease. The Jackson Hole Symposium, unofficially announcing the end of this tightening cycle, may take place from August 24th to 26th. Given the recent employment and macroeconomic data, this would indicate that the US economy is in an ideal state of growth for the so-called "Goldilocks" scenario, where economic growth is neither too hot nor too cold.

• There is a 10% probability that CPI YoY growth will be 2.7% or lower.

This tail risk scenario has a higher probability of occurring than other tail risk scenarios. If this scenario occurs, the S&P 500 index will rise by 2.5% to 3%, and the market will dismiss expectations of a rate hike by the Fed in July, while expectations for a rate cut in the fourth quarter of this year will increase.

Overall, the aforementioned team at J.P. Morgan believes that CPI data that has a dovish impact is more likely to occur than hawkish results. We will see enough downward pressure on inflation to end the Fed's rate hike cycle. The June CPI will bring the market closer to the ideal state of economic growth, profit growth, and normalization of inflation, known as the "Goldilocks" scenario.

Goldman Sachs: Core CPI most likely to increase MoM by 0.2% to 0.29% in June

Goldman Sachs' sell-side research predicts that the MoM growth rate of CPI in June will accelerate from 0.1% in May to 0.25%, slightly lower than the consensus expectation of 0.3%. The YoY growth rate is expected to slow down from 4.0% in May to 3.08%, also slightly lower than the consensus expectation of 3.1%. In June, the MoM core CPI increased by 0.22%.

Jan Hatzius, Chief Economist at Goldman Sachs, predicts that June CPI will reflect three key subcategory price trends: 1) a 1.2% decrease in used car prices and a 0.2% decrease in new car prices, reflecting a decline in auction prices for used cars and an increase in promotions by car dealerships; 2) residual seasonal factors may exert pressure on inflation in the tourism category, with a 2% decrease in hotel and public transportation prices, possibly due to an overfitting of price rebounds after the lockdown during the COVID-19 pandemic; 3) the narrowing gap between new lease rents and renewal rents will partially alleviate housing inflation, with a 0.47% increase in rents and OER (Owners' Equivalent Rent).

Goldman Sachs trader John Flood pointed out that federal funds futures currently indicate a probability of over 90% for a 25 basis point rate hike by the Federal Reserve in July, making it highly unlikely that the Fed will abandon the idea of a rate hike in July within the next two weeks.

Flood outlined several possible market reactions:

The probability of a MoM core CPI increase exceeding 0.5% in June is 5%, and if this occurs, the S&P 500 will drop by at least 2%.

The probability of a MoM core CPI increase ranging from 0.4% to 0.5% in June is 10%, resulting in a 1% to 2% drop in the S&P 500.

The probability of a MoM core CPI increase ranging from 0.3% to 0.39% in June is 30%, resulting in a 0% to 1% drop in the S&P 500.

The probability of a MoM core CPI increase ranging from 0.2% to 0.29% in June is 35%, resulting in a 0% to 1% increase in the S&P 500.

The probability of a MoM core CPI increase ranging from 0.1% to 0.19% in June is 15%, resulting in a minimum 1% increase in the S&P 500.

Flood also pointed out that options contracts imply a volatility of only about 0.7% for the S&P 500 on the day of CPI release this week. The chart below shows the implied S&P volatility and realized volatility on CPI release days since January last year, with relatively higher volatility in October and November.