U.S. Stocks Cautious Ahead of CPI as Fed Hike Expectations Rise

U.S. stocks closed lower again yesterday, and futures are modestly higher on Friday as Treasury yields hit multi-year highs, oil topped $109 a barrel, and August PPI data underscored the impact that rising energy costs are having ahead of CPI data today.

The Dow Jones fell 0.6% yesterday, its fourth straight daily decline, while futures are up 0.4% on Friday as investors weigh up an increasingly challenging macro backdrop.

All eyes on US CPI data

Expectations are for CPI to rise 3.4% YoY and 0.4% MoM. Core inflation is expected to rise 2.4% YoY and 0.2% on a monthly basis.

Following last Friday’s stronger-than-expected NFP report, the Fed’s primary concern is inflation. This, combined with considerable uncertainty surrounding the FOMC’s decision-making framework under new Fed Chair Kevin Warsh, means that August CPI could well determine the Fed’s rate decision next week.

The data comes after the producer price index rose 0.4% month-on-month in August, up from 0% in July, and was 5.4% year-on-year, owing to the recent spike in oil prices and highlighting the impact of rising energy costs.

Meanwhile, Brent remains at multi-month highs after reaching $109 a barrel, its highest level since May 19, marking oil’s eighth straight day of gains and its longest winning streak in three years, as increasing hostilities in the Middle East lift the risk premium on oil.

The market is pricing in a 70% probability that the Fed will hike rates in September, up from 60% prior to the release of the PPI data. Hot inflation, combined with September’s surge in energy prices, has tipped the balance towards a hike next week.

The yield on the 30-year Treasury is at its highest level since 2004, while the 10-year Treasury yield is at its highest close since April 23. This combination of higher oil prices and rising bond yields has pressured risk assets.

How the market could react to CPI data

Hotter-than-expected CPI data today could see yields rise further, lifting the USD while dragging stocks and gold lower.

However, any easing in inflation could spark a near-term rebound in equities. For a longer-term improvement in risk sentiment, the market will need to see optimism towards a deal in the Middle East return, oil prices fall and Treasury yields ease.

Without these factors aligning, it is difficult to see why investors would significantly increase equity exposure.

Dow Jones Technical Analysis

The Dow Jones faced rejection at 53,500, breaking below the rising trend line and the 50 EMA which, combined with the RSI below 50, keeps sellers hopeful of further downside. This latest pullback raises the chances of a deeper correction.

Sellers are testing support at 52,000 and the 100 EMA at 51,850. A break below here opens the door to 51,060, the July low, before exposing the 200 EMA at 50,300. Below here, selling could gain traction as attention turns to 50,000.

Any recovery would first need to rise above the 50 EMA at 52,800, while a break above 53,825 creates a higher high, bringing 54,750 into focus.