On Wednesday morning, the U.S. Bureau of Labor Statistics will release June data from the closely watched Consumer Price Index (CPI), which tracks the prices of a basket of daily goods and services. Investors use the CPI as one way to measure inflation, which has hit a 40-year high this year and forced the Federal Reserve to become increasingly hawkish in terms of monetary policy.
While CPI data comes out every month, the reading on Wednesday will be watched more closely than normal, as are the current high levels of inflation. That's why the data on Wednesday has the potential to significantly move markets one way or the other. Here's why.
High inflation has been crushing stocks
The high levels of inflation seen this year have become a real problem. Prices on everything from gas to food to rent have been sky-high, and this has investors worried about the state of the consumer, which can really drive the economy one way or the other.
US Consumer Price Index YoY data by YCharts
In May, the CPI rose a whopping 8.6% from May of 2021 and came in higher than the 8.3% rate economists had been projecting. Many investors right before the May report had thought that consumer prices and therefore inflation had peaked. This needs to happen because if inflation persists, the Federal Reserve will have to keep being aggressive with interest rate hikes. The Fed has already done one 75-basis-point (0.75%) hike, in June, and another could be on the docket for later this month.
Rate hikes are problematic for stocks because they raise the cost of debt for consumers, make it more expensive for businesses to operate, and reduce future cash flows. They also make safer assets yield more, putting pressure on high valuations.
With such rapid rate hikes, the Fed could also tip the economy into a recession, something that many investors think has already happened. The Fed has also acknowledged that it will have to get more restrictive with its monetary policy if inflation doesn't peak soon. Unfortunately, many experts do not believe June data will be friendly to the market.
Deutsche Bank's chief U.S. economist, Matthew Luzzetti, recently told Yahoo! Finance that his team thinks the CPI will show a year-over-year increase of close to 9% in June. While he thinks the recent decline in oil and gas prices should be helpful, Luzzetti also said that he thinks Wednesday's report will be all about rents, which have been marching higher this year. Luzzetti explained:
And if you get another strong [inflation] print there, it's really evidence of broad-based underlying inflation pressures in the U.S. economy at a time where very clearly growth is slowing. And I think that puts the Fed in a bind. So far, we've heard them remain hawkish. We think they continue with a 75-basis-point rate hike at the end of this month. But later this year could be quite difficult for them if inflation remains elevated and the labor market begins to weaken.
Stocks may move significantly on Wednesday
I have no idea what the CPI will come in at on Wednesday or how the market will react. But if the CPI reads higher than economists are expecting, stocks may sell off on concerns about persistent inflation. If it comes in lower, investors may start buying stocks, and the Fed might even consider a 50-basis-point rate hike at its July meeting. There's no way to know for sure because investors don't always behave rationally.
But keep in mind that the CPI data about to come out is for June, so while it is an important snapshot, it is a snapshot of the past, and the situation may have already changed.
I would not recommend buying or selling stocks specifically in preparation for Wednesday's report release because the market is extraordinarily volatile right now and is nearly impossible to time (not trying to time the market is generally good advice for long-term investors anyway). Continue to buy good companies with good long-term outlooks at good valuations. But it wouldn't hurt to prepare yourself mentally for some potential market movement on Wednesday.
