Here’s how Wednesday’s inflation report could push U.S. stocks even higher

The report caused a splash in the markets, sending shares of troubled used-car sales platform Carvana Co down.

CVNA

It rose 16% on Monday and rose nearly 3% to $36 a share on Tuesday, according to FactSet.

Brighter expectations for Wednesday’s CPI report helped lift U.S. stocks on Tuesday, analysts told MarketWatch.

Fundstrat’s Tom Lee’s latest call for the S&P 500 to gain 100 points, or 2.3%, this week shows expectations for inflation falling faster than expected.

See: S&P 500 could rise 100 points this week on inflation data, says Fundstrat’s Lee

Lee’s rationale is simple: Declining inflation reduces pressure on the Fed to raise interest rates, and the Fed will quickly cut interest rates, or at least not raise rates.

Jason Traho, head of asset allocation for the US at UBS Global Wealth Management, explained what the sudden pullback in inflation means in an emailed commentary to markets.

“Both the headline and core CPI for June are expected to ease slightly, and the 3-month annualized core measures are likely at 2%,” he said.

“That level will convince enough investors that inflation is ‘settled’ for a few months. If that happens, the Fed will have less reason to hold rates longer, reducing the risk of a recession.

Economists polled by The Wall Street Journal expect year-over-year inflation to ease to 3.1% from 4.0% and year-over-year core inflation to fall to 5.0% from 5.3%.

In an attempt to anticipate what will happen, analysts focus on a few leading indicators, such as the Mannheim Used Car Index, which has gained popularity on Wall Street as a reliable inflation predictor.

Deutsche Bank’s Jim Reid shared a chart illustrating the relationship between the Mannheim index and the used cars and trucks component of the CPI, showing that the latter closely tracks the former.

If this relationship holds, it means that core commodity prices could drag down broader measures of inflation in the second half.

Goldman Sachs Group Chief Economist John Hutchius said in a note to clients that he believed CPI could beat consensus by coming in at 0.2% month-on-month, citing a decline in used car prices as one reason for lowering his estimate.

“Going forward, we expect monthly core CPI inflation to be around 0.2-0.3%.
The average range over the next few months reflects continued moderation
Housing inflation, lower used car prices and slower non-housing inflation
As labor demand continues to moderate,” he said in the note.

Of course, some believe that the use of the Mannheim index has already declined. Spectra Markets’ Brent Donnelly showed that the Mannheim remained a reliable predictor of core inflation between 2020 and 2022, after a decade of nearly zero inflation in the US as price pressures began to mount, however, its reliability began to weaken as inflation cooled to record highs. The position has been more than four decades since last summer.

Economists’ median estimates have been more accurate since the start of the year in predicting inflation, reducing the odds of a significant negative surprise, Donnelly said.

Eastern investors will know at 8:30 a.m. on Wednesday what the exact inflation numbers are for June according to the CPI. Meanwhile, the central bank’s preferred PCE price index will be released later this month.

So far, US stocks have outperformed the S&P 500 this week

SPX

,
Nasdaq Composite

COMP

and the Dow Jones Industrial Average

DJIA

All ended higher on Tuesday, partly due to optimism surrounding the inflation report. The S&P 500 rose 0.4% to 4,428, according to FactSet data.

Markets have seen some volatility of late. The S&P 500 has fallen in two of the past three weeks, marking its longest winning streak since late 2021, according to FactSet data.