US Stocks Drop Despite Inflation Slowdown as Rate Cut Speculation Grows | Daily Market Analysis

Key events:

• USA - PPI (MoM) (Jun)
• Canada - Building Permits (MoM) (May)
• USA - Michigan Consumer Sentiment

US stocks fell on Thursday despite inflation data suggesting a slowdown in the US economy, which raised the possibility of Federal Reserve interest rate cuts later this year.

The S&P 500 dropped 0.88%, retreating from its previous record to close at 5,584.54. The Nasdaq Composite also declined, falling 1.95% to end at 18,283.41, with Nvidia (NASDAQ: NVDA) shares plummeting over 5.5%. Conversely, the Dow Jones Industrial Average inched up by 32.39 points, or 0.08%, finishing at 39,753.75.

Small-cap stocks, as represented by the Russell 2000 Index, surged by 3.6%. This rise was fueled by expectations of a Federal Reserve rate cut in September and hopes for an economic soft landing, reinforced by the latest inflation data.

After the CPI announcement, Treasury yields fell as traders increased their bets on forthcoming interest rate cuts. The likelihood of a rate reduction in September rose to about 93%, according to the CME FedWatch Tool, though the market consensus is that the Fed will maintain rates at its upcoming meeting later this month.

Earlier data on Thursday showed the June Consumer Price Index decreased by 0.1% on a monthly basis, contrary to the expected 0.1% increase. Annually, it rose by 3%, below the anticipated 3.1% rise. The core CPI, which excludes volatile food and energy components, increased by just 0.1% monthly and 3.3% annually, slightly under the forecasted 3.4% rise.

These figures have heightened expectations that the Federal Reserve might start cutting rates as soon as September at its next policy-setting meeting.

On Wednesday, the main indices on Wall Street surged to new record highs following positive comments from Fed Chair Jerome Powell, who noted the recent cooling in the US economy but remained confident in achieving a soft landing.

During the second day of his semi-annual Congressional testimony, Fed Chair Jerome Powell informed lawmakers that "more good data" would strengthen the argument for the US central bank to cut interest rates. However, several Fed officials have expressed caution, emphasizing the need for more evidence of cooling inflation before voting for rate cuts, as inflation remains above the bank's 2% target.

The Japanese Yen pared its gains as the US Dollar strengthened, buoyed by rising Treasury yields. However, the JPY's volatility is expected to continue amid speculation of potential intervention by Japanese authorities following weaker-than-expected US CPI figures. Japanese Chief Cabinet Secretary Yoshimasa Hayashi expressed readiness to use all available measures regarding forex, noting that the Bank of Japan will decide on monetary policy specifics.

Hayashi expects the BoJ to implement appropriate measures to sustainably and steadily achieve the 2% price target, as reported by Reuters on Friday. The anticipation of a possible interest rate hike by the BoJ at its upcoming July meeting has also bolstered the JPY, contributing to a decline in the USD/JPY pair.

Gold prices saw significant positive traction on Thursday, rallying to the $2,424-2,425 region, the highest level since May 22. This rise followed a subdued US inflation report that increased bets on a Federal Reserve rate cut in September. However, gold's upward momentum lacked follow-through buying amid a modest rebound in the US Dollar, supported by a pickup in US Treasury bond yields. This, coupled with bullish sentiment in equity markets, led to some selling of the safe-haven precious metal during the Asian session on Friday.

Despite snapping a three-day winning streak, gold's meaningful corrective downturn remains unlikely given the expectations of an imminent Fed rate cut. Additionally, political uncertainty in the US and Europe, alongside geopolitical risks and concerns about a global economic slowdown, should provide tailwinds for XAU/USD, warranting caution for bears.

The Australian Dollar trades near its six-month high of 0.6798 recorded in the previous session. The AUD/USD pair found support as the US Dollar weakened following softer-than-expected US CPI data for June, raising expectations of a potential Fed rate cut in September. China, a key trade partner for Australia, reported a trade surplus of $99.05 billion for June, up from the previous figure of $82.62 billion.

Changes in the Chinese economy could significantly impact the Australian Dollar. The AUD may extend its gains as speculation grows that the Reserve Bank of Australia might delay the global rate-cutting cycle or even raise interest rates again. Persistently high inflation in Australia prompts the RBA to maintain a hawkish stance.

Traders now await the release of the US Producer Price Index and the University of Michigan Consumer Sentiment survey for further market direction during the North American session.