Inflation Just Dropped a Massive Hint About the Fed’s Next Move

The major U.S. stock indexes inched up on Tuesday as investors digested mixed producer inflation data and turned their focus to the much-anticipated consumer price index report due out on Wednesday.

The producer price index (PPI) for April showed prices paid by businesses for inputs and supplies increased 0.2% from the prior month, slightly above economists’ expectations of 0.1%. On an annual basis, PPI rose 2.3%, decelerating from March’s 2.7% pace but still higher than forecasts.

The “hot” PPI print caused traders to dial back bets on an interest rate cut from the Federal Reserve at its September meeting. Fed funds futures showed only a 48% implied probability of a 25 basis point rate cut in September, down from around 60% before the report.

Speaking at a banking event in Amsterdam, Fed Chair Jerome Powell characterized the PPI report as more “mixed” than concerning since revisions showed prior months’ data was not as hot as initially reported. He reiterated that he does not expect the Fed’s next move to be a rate hike, based on the incoming economic data.

“My confidence [that inflation will fall] is not as high as it was…but it is more likely we hold the policy rate where it is [than raise rates further],” Powell stated.

Investors are now eagerly awaiting Wednesday’s consumer price index data as it will provide critical signals on whether upside inflation surprises in Q1 were just temporary blips or indicative of a more worrying trend.

Consensus estimates project headline CPI cooled to 5.5% year-over-year in April, down from 5.6% in March. Core CPI, which strips out volatile food and energy prices, is expected to moderate slightly to 5.5% from 5.6%.

If CPI comes in hotter than projected, it would solidify expectations that the Fed will likely forego rate cuts for several more months as it prioritizes restoring price stability over promoting further economic growth.

Conversely, cooler-than-forecast inflation could reinforce the narrative of slowing price pressures and clear the path for the Fed to start cutting rates as soon as June or July to provide a buffer against a potential economic downturn.

The benchmark S&P 500 index closed up 0.18% on Tuesday, while the tech-heavy Nasdaq gained 0.43%. Trading was choppy as investors bided their time ahead of the CPI release.

Market focus has intensified around each new inflation report in recent months as investors attempt to gauge when the Fed might pivot from its aggressive rate hike campaign of the past year.

With inflation still running well above the Fed’s 2% target and the labor market remaining resilient, most economists expect the central bank will need to keep rates elevated for some time to restore price stability. But the timing and magnitude of any forthcoming rate cuts is still hotly debated on Wall Street.