Note to readers: Please check out this article on Powell's testimony.
When Federal Reserve Chairman Jerome Powell appears before the Senate banking panel today at 10 a.m., the S&P 500 will be braced for an answer to investors' long-standing question about the pivot to rate cuts: "Are we there yet?" His response and Thursday's CPI may determine whether the bull market can stay in gear or is at risk of stalling.
Fed Chair Powell
There are two things Wall Street will be happy to hear from Powell and two things that may put pressure on stocks.
The first big test will be how Powell characterizes the labor market. At his news conference after the June 12 Fed meeting, Powell summed it up this way: "Overall, we're looking at what is still a very strong labor market, but not the superheated labor market of two years ago or even one year ago.
Yet investors have reason to hope that Powell downgrades his assessment after Friday's soft June jobs report, which included big downward revisions to hiring gains in April and May. Over the past three months, net hiring by private firms has slowed to a monthly average of 146,666, the least since the pandemic shutdown.
The jobless rate unexpectedly climbed to 4.1%, which is the highest since late 2021 and even higher than the Fed's 4% projection for the end of 2024. Unemployment is rising because the number of people entering or reentering the labor force has overtaken new job creation. Meanwhile, 12-month wage growth has fallen below 4%.
If Powell maintains the view that the labor market is still basically strong, financial markets may be unpleasantly surprised. That would signal less urgency to lower the Fed's key interest rate. A recognition that job growth has slowed to a moderate pace and is at risk of slowing too much amid restrictive monetary policy would likely boost investors' risk appetite.
Powell's 'Consequential Decision'
Two other potential signals will be worth listening for. In June, Powell explained that the Fed was being especially careful not to cut rates too soon because the initial rate cut of a cycle is "a consequential decision for the economy."
Powell explained further: "When we do start to loosen policy, that will show up in a significant loosening in financial market conditions."
A rate cut will stimulate business investments and borrowing that are on hold until the Fed acts, giving the economy new momentum. However, Powell also may be thinking about the impact on the S&P 500. Stock prices are a major contributor to financial conditions and have been the biggest reason why current financial conditions have been easier than they were when the Fed started hiking in March 2022.
If Powell repeats that phrase, it may signal that the Fed is worried about financial conditions getting too easy and that policymakers could remain stingy with rate cuts.
On the other hand, Powell might increase confidence in multiple rate cuts this year if he explicitly walks away from the Fed's June projection. That forecast penciled in just 25 basis points in rate cuts this year, down from a projection of 75 basis points in March.
CPI
"We are getting back on a disinflationary path," Powell said at a European Central Bank forum last week.
The consumer price index for June, out Thursday at 8:30 a.m., could provide more confirmation that inflation is back on track to return to the Fed's 2% target.
Economists expect a 0.1% overall CPI increase on the month, with a 0.2% rise in the core CPI, which strips out food and energy.
Deutsche Bank expects a 0.25% rise in the core CPI as May's decline in transportation services prices could lead to a rebound in June. However, Nomura predicts a tame 0.135% core CPI increase, thanks to lower prices for hotel and motel stays, as well as lower airfares.
Fed Rate-Cut Outlook
As of Tuesday morning, markets are pricing in 77% odds of a Fed rate cut at the Sept. 18 meeting and 73% odds of two quarter-point rate cuts before the end of 2024.
If Powell sounds dovish about the labor market today and the core CPI is tame, markets might raise the odds of a third rate cut from around 25% to above 50%.
A double-dose of good economic news should keep the S&P 500 rally in gear because a more proactive Fed should ensure a soft landing for the economy. But if Powell doesn't change his tune on the labor market and the CPI fails to soothe, markets may begin to price in a risk of the Fed reacting too slowly to avoid a big slowdown for the economy and S&P 500 earnings.
S&P 500
The S&P 500 traded added a fraction higher on Monday, enough to chalk up its 35th record high this year. The S&P 500 has climbed 17% in 2024.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
