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Latest inflation data provides potential for 'even greater upside' in the stock market rally

After a rough start to 2024, the latest inflation data may very well mean more fuel for the current stock market rally.

"Inflation falling continues to be one of the primary factors behind the bull market in stocks," Julian Emanuel, who leads Evercore ISI's equity, derivatives, and quantitative strategy, wrote in a note to clients.

On Sunday, Emanuel boosted his year-end price target for the S&P 500 (^GSPC) to 6,000 from 4,750. Emanuel cited the promising inflation path and the “early innings” of the AI trade when moving his year-end target to the highest on Wall Street.

The S&P 500 and Nasdaq (^IXIC) hit four straight record closes last week as investors digested softer-than-expected inflation readings for both consumer and wholesale prices.

UBS Investment Bank's chief US equity strategist Jonathan Golub, who holds one of the highest S&P 500 year-end targets on the Street at 5,600, believes this week's inflation data and what it could mean for eventual interest rate cuts "provide the potential for even greater upside" to his year-end outlook.

Golub's confidence is increasing because inflation is showing its most significant progress toward the Fed's 2% goal since the start of the year. That is fueling hopes for rate cuts — and sending Treasury yields, a noted headwind for stocks over the past year, lower.

The May Consumer Price Index (CPI) showed "core" CPI, which excludes volatile food and energy categories, increased by 0.2% month over month, the lowest reading since June 2023. Meanwhile, the "core" Producer Price Index (PPI), which excludes the volatile food and energy categories, was unchanged in May from the prior month, below economists' expectations for a 0.3% increase.

Combining the various metrics, economists believe this points to a positive reading of the Fed's preferred inflation gauge within the Personal Consumption Expenditures (PCE) index later this month.

Bank of America US economist Stephen Juneau wrote that Thursday's PPI supports their view that "disinflation is the most likely path forward" and points to an "A+ report" for May core PCE. BofA estimates core PCE increased 0.16% month over month in May.

"The May CPI and PPI data are favorable for our view that the Fed will be reducing its policy rate later this year," Juneau wrote. "We see recent inflation data as greatly reducing the likelihood that the Fed has to raise rates and view labor market data as indicating that the probability of fast rate cuts is also low.

"An easing cycle that begins in September remains a possibility, particularly if shelter inflation were to moderate further in the next couple of months."

The inflation data seems to have cheered investors in the face of the Fed's latest Summary of Economic Projections (SEP), which showed the median forecast for rate cuts fell to just one cut in 2024. Markets are now more firmly pricing in two interest rate cuts this year than they had entering the week.

Some attribute this to when the data was released. The CPI report came just hours before the Fed released its — and while Fed Chair Jerome Powell noted that officials are allowed to change their forecast after an economic data release, "most people don’t."

Additionally, the Fed's call was close, with just one more official favoring one cut rather than two. Between the narrow majority and the second positive inflation reading of the week coming after the Fed had already wrapped its meeting, Wall Street strategists believe the Fed's forecast may already be stale.

"Honestly, if [the inflation data] happened a week earlier, I think that might just have been enough to keep another two people on the two-rate-cut bandwagon," JPMorgan Asset Management chief global strategist David Kelly said at a media roundtable on Thursday.

Kelly said the recent data added to the case that inflation is falling slowly toward the Fed's 2% target. And unless the US economy is hit by an unexpected shock to reverse course, "the soft landing continues," Kelly said.

FILE - Federal Reserve Board Chair Jerome Powell speaks during a news conference at the Federal Reserve in Washington, May 1, 2024. On Wednesday, June 12, 2024, the Federal Reserve will end its latest meeting by issuing a policy statement, updating its economic and interest-rate projections and holding a news conference with Powell.(AP Photo/Susan Walsh, File)
Does he reserve the right to change his mind on rate cuts? Federal Reserve Board Chair Jerome Powell (AP Photo/Susan Walsh) (ASSOCIATED PRESS)

Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.

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