This week's inflation data heartened investors. Equities and commodities rose while bond yields and the dollar fell. The question is whether the data will convince the Fed to relent on keeping interest rates higher for longer.

 

If we take a long-term view, the Consumer Price Index (CPI) change was minuscule. For April, inflation gains slowed from 3.5 percent to 3.4 percent, while core inflation increased over the last 12 months by 3.4 percent compared to 3.5 percent in March. That's no big deal, and yet, the numbers did break the trend of warmer CPIs over the last three months.

 

The cooler inflation announcement caught investors by surprise since most observers were convinced that inflation would continue the trend of hotter numbers. Readers may recall what I wrote in last week's column:

 

"The ramifications for the equity and bond markets could be serious. A weak inflation number in one or both indexes would be taken positively, I imagine with stocks climbing, possibly to new highs, and bond yields falling. It would also be beneficial for the commodity space and could push precious metals and copper higher. On the other hand, hotter numbers would have the opposite effect.

 

No one knows for sure, but readers aren't paying me for "on the other hand" opinions. So, I will come down on the side of cooler numbers next week. I base my guess on things like used car prices that have come down by about 30 percent thus far in 2024 and are accelerating to the downside. Insurance premium increases have been the major culprit in the hotter CPI data thus far and I am expecting at least a leveling out of price increases in car insurance this month.

 

That was exactly what happened. Stock indexes made record highs, yields fell, and commodities, especially gold, silver, and copper, soared. The question I am asking myself is now that we are above yearly highs on several indexes, are we jumping the gun here? Do you think the Fed is going to abruptly change its stance on one cooler inflation number?

 

I still don't think the data supports a change in Fed policy. The bond market disagrees. Traders are certainly upping their odds (again) for a cut in June, with more to follow. Sure, it could happen, but I won't hold my breath. Frankly, the Fed has already begun the easing process by reducing its Quantitative Tightening (QT). QT occurs when the Fed ups the amount of bonds they sell into financial markets from their balance sheet. That reduces the cash (liquidity) in the system.

 

At the beginning of May, the Fed announced it would slow down bond selling by over half from $60 billion per month to $25 billion. That is roughly equivalent to a 25-50 basis point cut in interest rates. At this point, I suspect the health of the labor market would influence the Fed more than one inflation reading. If unemployment increased suddenly (especially in an election year), the Fed might change its mind. Presently, while job gains have slowed, employment is still at almost historical lows.

 

As far as the markets are concerned, if markets continue to believe that the next move from the Fed will be an interest rate cut, risk assets will continue to gain, while the dollar and yields will decline further. I could see 5,340 on the S&P 500 Index, but I think Nvidia's earnings on May 22 will be crucial to where the market goes next. The entire AI rally and the gains in the technology sector for the year hinge on this AI chip producer. I believe it will set the stage for sentiment and earnings for the remainder of the month.

 

The markets have had a good run over the last two weeks. Is it time for a break? If so, I would call it a pause, where traders consolidate gains, catch their breath, and prepare for the summer. I expect to see a couple of days of profit-taking, especially in those areas that have seen outsized gains. That would be ideal, reduce overbought conditions and set up for another ramp higher in June.

 

June should be a period where markets grind higher. I am expecting a lot of rotation as well. Underperforming sectors will be squeezed higher, and favored areas will see bouts of profit-taking. By the end of August, we could see as high as 5,600 on the S&P 500 Index.

 

By the way, have you checked out the Chinese stock market since my column "China is on a tear?"

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.