US CPI joins forces with FOMC for a heavyweight attack, the market is preparing to face a "night of terror"!

"The Most Exciting Wednesday" is here, with the US CPI and the Federal Reserve's decision tonight, global investors are on high alert.

Here are the key points:

• Focus on the month-on-month core CPI. If the core CPI and the crucial OER rent are weaker than expected, the market may start pricing in a rate cut in July.
• The month-on-month core CPI will also be a key variable determining the rise and fall of US stocks that day. The core inflation rate needs to increase by more than 0.3% to put pressure on the market. With a probability of 25% for a range between 0.25% - 0.30%, the S&P 500 index is expected to rise by 0.75% to 1.25%.
• This FOMC meeting is highly likely to "stand pat". Most analysts expect that the number of rate cuts forecasted in the March dot plot for the year may be revised down from three times to two times or even once, with some even predicting no rate cuts this year.
• If inflation heats up unexpectedly again, it may prompt more Fed officials to revise down the number of rate cuts for this year to once on the dot plot; if the data is broadly in line with expectations, the expectation of two rate cuts this year may prevail.

Will the May CPI Data Change the Dot Plot?

The importance of the US May CPI data to be released tonight is undeniable, as this data will be a reference for the Fed's FOMC to release the "dot plot". Wall Street optimistically expects a downward trend in inflation. If the core CPI and crucial OER rent are weaker than expected, the market may start pricing in a rate cut in July.

At 20:30 Beijing time, the US Department of Labor will release the May CPI data. Most believe that inflation will slow down. The current consensus forecasts are:

The month-on-month May CPI is expected to rise by 0.1%, slowing down from the previous 0.3%, with a stable year-on-year increase of 3.4%;

The core CPI excluding food and energy is expected to be 0.3%, consistent with the previous value, with the year-on-year increase expected to slow down from 3.6% to 3.5%.

It is worth noting that a few forecasts predict that the month-on-month core CPI will slow down to 0.2%. If the core CPI growth rate is lower than expected, especially if OER performs very weakly, it may trigger a rapid market response, even pricing in a rate cut by the Fed in July.

Looking at the breakdown, goods inflation continues to maintain a "declining trend", while stubborn service inflation is starting to weaken.

Key housing inflation, which accounts for 1/3 of the CPI weight, is expected by Goldman Sachs to see stable growth in rent and OER month-on-month at 0.35% and 0.42%, while UBS is more optimistic, believing that OER will be below 0.40% for the first time. Due to the lag in housing inflation data, the expected slowdown trend is expected to continue in the future.

In other core inflation aspects, core commodity prices have basically returned to pre-epidemic levels. Due to rising leading indicators such as auctions, the price of used cars is expected to rebound by 0.3% in May, but inflation in transportation, healthcare, and other services will further slow down.

Energy prices weaken overall inflation, with gasoline, electricity, and fuel prices slightly decreasing, while natural gas prices have slightly increased. Due to seasonal factors, food prices are expected to rise by 0.2% month-on-month.

Although U.S. inflation continues to cool down, some Federal Reserve officials still emphasize the need to remain patient and see inflation decline in the future. Analysis points out that if inflation heats up again beyond expectations, it may prompt more Fed officials to reduce the number of rate cuts this year in the "dot plot" to once; if the data largely meets expectations, the expectation of two rate cuts this year may prevail.

The Fed may continue to stand pat, focusing on economic forecasts, dot plot, and Powell's speech

Six hours after the CPI data is released, which is early Thursday morning Beijing time, the Federal Reserve will announce the highly anticipated June monetary policy decision.

Despite the preemptive rate cuts by the ECB and the BOJ, the market generally expects that the Fed will continue to stand pat this time, keeping interest rates unchanged in the range of 5.25%-5.5%. At that time, the market will focus on the Fed's latest economic forecasts and dot plot, as well as Fed Chairman Powell's remarks later, to look for clues about the future direction of monetary policy.

Most analysts expect that the number of rate cuts forecasted in the June dot plot may be reduced from three times in March to two times, or even once, with some even predicting no rate cuts this year.

Among them, Goldman Sachs expects the Fed to cut rates twice this year, with the first rate cut as early as September; Morgan Stanley expects only one rate cut this year; Citigroup maintains its view of three rate cuts; while UBS believes that if the Fed signals a rate cut, it may not come until November or December for the first rate cut this year.

Considering the high interest rates and the highlighted "stickiness" of inflation, the Fed is likely to lower its economic growth forecasts for the next two years, raise unemployment rate and inflation expectations.

FOMC Vice Chairman and New York Fed President Williams gave his personal expectations earlier: the inflation rate for this year is 2.5% (higher than the Fed's March forecast of 2.4%), approaching 2% by 2025 (slightly lower than the Fed's March forecast of 2.2%), economic growth in 2024 will be between 2.0-2.5%, unemployment rate at 4.0%, basically in line with the Fed's forecast.

However, there are two issues worth noting here.

One is that the May CPI data may influence the final dot plot. If the CPI performs poorly again, proving that "stickiness" still exists, more officials may choose to cut rates only once this year or even not at all. Conversely, if inflation unexpectedly falls back, a consensus on two rate cuts may be reached. The Fed is likely to have seen this inflation report before the marketSecond, the limitations of dot plots themselves. Due to the small number of FOMC officials (19 in total), a change of mind by individual officials could affect the final median forecast. Therefore, it is still necessary to judge the policy outlook based on the latest actual data and public speeches by Federal Reserve officials.

Powell will hold a press conference at 14:30 Eastern Daylight Time, and many investment banks such as Goldman Sachs expect that his stance will not undergo major changes. Powell previously stated that the data in the first quarter of this year has reduced confidence in cooling inflation, making it difficult for the Fed to determine whether or when to cut interest rates.

Currently, there is an unusually high level of consensus within the Federal Reserve to "wait and see." Officials unanimously believe that the labor market remains relatively strong, inflation, although falling, is still above the 2% target, and the best choice at present is to keep interest rates unchanged and observe the future.

However, the economic outlook is not without challenges. Recent economic data has shown signs of weakness, especially in the real estate market. While the labor market has not deteriorated significantly, there has been a slight increase in business layoffs, and wage growth has cooled more than during the pandemic. This means that as long as inflation cools down smoothly, the Fed will have more room to adjust its policies.

How Stimulating Will the Market Be Tonight?

Goldman Sachs trader Lee Coppersmith made a prediction on the market reaction after the release of CPI data (the left column in the chart shows the month-on-month growth rate of core CPI, and the right column shows the corresponding forecast of the S&P index), he believes that the month-on-month growth rate of core inflation needs to be above 0.3% to put pressure on the market.

JP Morgan also believes that the month-on-month growth rate of core CPI is the key variable determining the rise and fall of the US stock market for the day, and has made the following deductions:

• Above 0.4%, with a 5% probability, in this scenario: expectations of rate cuts in 2024 will disappear, the market may reconsider rate hikes, bond yields may rise by 12-15 basis points, and the S&P 500 may fall by 1.5% to 2.5%.
• Between 0.35% and 0.40%, with a 15% probability, in this scenario: expectations of rate cuts in September and November will decrease, the bond market will be under pressure, and the S&P 500 may fall by 1% to 1.25%.
• Between 0.30% and 0.35%, with the highest probability of 40%, in this scenario: the impact on the bond market is relatively mild, and the S&P 500 index may fall by 0.75% or rise by 0.75%
• Between 0.25% and 0.30%, with a probability of 25%, this scenario is positive for risk assets. The Goldilocks narrative may return to the market, and the S&P 500 index is expected to rise between 0.75% and 1.25%.
• Between 0.20% and 0.25%, with a probability of 12.5%, if this occurs, the expectation of a rate cut in September will surge. Some may even anticipate a preventive rate cut in July. It is expected that the yield curve will steepen, benefiting cyclical and value stocks. The S&P 500 is expected to rise between 1.25% and 1.75%.
• Below 0.20%, with a probability of only 2.5%, in this scenario: the expectation of a rate cut in July will significantly increase, U.S. bond yields will plummet, and all risk assets (except commodities) will rebound. The stock market will see a general rise, with the S&P expected to rise between 1.75% and 2.50%. The performance of the Nasdaq 100 index and the Russell 2000 index will outperform the S&P 500.

Regarding the Federal Reserve interest rate decision, maintaining the interest rate is a foregone conclusion, with the key lying in the dot plot and Powell's remarks.

The updated dot plot roughly has the following three scenarios:

1. Baseline scenario: Median expectation for two rate cuts by the end of 2024
2. Dovish scenario: Median expectation for three rate cuts by the end of 2024
3. Hawkish scenario: Median expectation for one rate cut by the end of 2024

Currently, the baseline scenario, where the probability of a decrease in the number of rate cuts compared to the previous year is the highest on the dot plot, Goldman Sachs believes that although this is not surprising, it may also create new upward pressure on yields and bring downward pressure to the stock market