Powell's cautious remarks do not hinder US stocks from reaching new highs! Investors' focus has shifted to CPI

According to the Zhitong Finance and Economics APP, the US stock market hit a historic high as of the close of trading on Tuesday. Federal Reserve Chairman Jerome Powell's speech to Congress did not change the market's expectations for a rate cut this year. On Tuesday, financial stocks led the way, driving the S&P 500 index to its longest continuous rally since January. Short-term US Treasuries also performed well, with investors expecting them to benefit from loose monetary policy. Although Powell did not provide a specific timeline for rate cuts, he emphasized signs of cooling in the job market.

Michael Feroli of Morgan Stanley pointed out that Powell's comments continue to pave the way for rate cuts later this year. While Powell remains cautious on economic issues, much of the discussion has shifted to the final outcome of the Basel Accord.

Powell announced that regulators are close to reaching an agreement on plans to force large banks to hold more capital, marking a major victory for Wall Street banks. This reform is related to Basel III, aimed at preventing a recurrence of the financial crisis.

The S&P 500 index has set multiple records this year, with financial stocks such as Morgan Stanley, Citigroup, and Wells Fargo rising, while Tesla and Nvidia lead the way among large-cap stocks. However, Oracle's stock price fell as Elon Musk indicated that his AI startup would reduce its reliance on Oracle Cloud technology.

Figure 1

US Treasuries narrowed their losses after a $58 billion three-year Treasury bond issuance, but market trends were limited by turbulence in the European bond market. Swap traders continue to predict two rate cuts in 2024.

Market Reaction

Market analysts had varying reactions to Powell's speech, but generally agreed that he laid the groundwork for a possible rate cut in September, provided that future data supports the Fed's policy adjustments. Among them:

Senior analyst Peter Boockvar of The Boock Report gave a positive assessment of the Fed's policy outlook, believing that Chairman Powell showed a balanced view on economic prospects and dual mandates, leaving room for policy easing. Boockvar expressed confidence in a rate cut in September, believing that Powell's comments paved the way for this expectation.

Krishna Guha of Evercore, on the other hand, believes that while some in the market were expecting a more explicit signal for rate cuts, Powell's speech gently laid the groundwork for a cut in September. He emphasized that as long as future data, especially the upcoming inflation report, supports the Fed's assessment, the likelihood of a rate cut will increase.

Andrew Brenner of NatAlliance Securities noted that Powell's stance was more neutral than the market had expected, and expects this tone to be maintained in the coming days with the release of CPI data on Thursday. He also cautioned that significant rate market volatility may occur with the publication of the CPI data BMO Capital Markets' Ian Lyngen and Vail Hartman observed that the decline in the U.S. interest rate market is more due to supply-side pressures rather than the content of Powell's speech. They believe that the market's response to Powell's speech was tepid, with more focus on the upcoming bond supply.

Chris Larkin of Morgan Stanley E*Trade noted that Powell acknowledged that high rates could pose risks to the economy and labor market, which may encourage investors expecting rate cuts. However, he also emphasized the Fed's wait for more evidence of inflation cooling.

Peter Williams of 22V Research believes that Powell's speech maintained policy stability and conveyed a balanced signal. He thinks there is a possibility of a rate cut in September, but it may be delayed due to unexpected increases in the labor market or inflation data.

Stephen Brown of Kaye Macro believes that Powell has kept all policy options open, and the neutral tone of his opening statement is inconsistent with recent moderate economic activity data, enhancing his expectation of a rate cut in September.

Meanwhile, U.S. Treasury Secretary Janet Yellen's comments are in line with Powell's views, stating that the labor market is no longer driving inflation as it did in the early stages of the pandemic.

Risk Warning

J.P. Morgan's trading department warns investors that after a period of calm, the stock market may experience volatility this week. Options markets predict a 0.9% volatility range for the S&P 500 index before Thursday, matching the price of straddle options expiring that day. Andrew Tyler, head of U.S. market intelligence, points out that traders may bet on the Fed cutting rates twice in 2024 based on expectations of easing inflation, following the release of the latest Consumer Price Index (CPI) before the trading day.

The volatility range predicted by J.P. Morgan's trading department in the following figure shows that in the most optimistic and least probable scenario—where the monthly CPI growth is less than 0.1%, the S&P 500 index is expected to rise by 1%-1.75%. The most likely scenario is a monthly CPI growth of 0.15%-0.20%, with the S&P 500 index fluctuating in the range of 0.5%-1%.

The most pessimistic scenario is a monthly CPI increase of over 0.3%, with a probability of 2.5%. J.P. Morgan traders believe that such strong inflation data could trigger a 1.25%-2.5% decline in the S&P 500 index. This is the first tail risk scenario, indicating that investors may see a reversal in the process of cooling core goods inflation, thereby pushing up monthly inflation data.

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Following the recent release of employment data, some daring traders are closely monitoring the Sam Rule - a heuristic recession indicator proposed in 2019. Despite being relatively new, since 1970, it has accurately predicted the onset of economic recessions. With the US stock market nearing historic highs, traders' expectations of rate cuts this year are rising, enhancing hopes for an economic soft landing. However, any signs of instability in the labor market could shake this confidence, prompting traders to reassess their investment portfolios.

Investment in the technology sector on Wall Street has reached unprecedented levels. If the stock market rebound driven by artificial intelligence is hindered, risks may further increase, especially in cases of overvaluation and slowing profit growth. Lisa Shalett from Morgan Stanley's wealth management department warned that the market's upward momentum is weakening, breadth is narrowing, and there is complacency, adding uncertainty for investors betting on continued rise of large-cap tech stocks.

Citigroup's strategist Drew Pettit stated that although the uptrend in AI stocks shows no signs of slowing down, historical experience suggests that it may be time to consider taking profits. He pointed out that confidence in AI stocks has reached its highest level since 2019, with expectations that most companies' free cash flow will exceed analysts' expectations.

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Overall, investors need to remain vigilant in the current market environment, while upcoming economic data and policy trends are also worth closely monitoring