After Getting Rattled by BoJ, Wall Street Rebounds on Milder Inflation Reading

(Friday market open) Welcome signs of easing U.S. inflation propelled Wall Street to early gains Friday, but the market remains rattled following a policy tweak earlier from the Bank of Japan (BoJ) and worries about the Federal Reserve potentially tightening further.

Today’s Personal Consumption Expenditures (PCE) prices report showed the core prices rising 0.2% in June, down from 0.3% in May. That was in line with expectations and more evidence of a softer pricing environment. Core prices strip out food and energy. Core PCE rose 4.1% annually in June, down from 4.6% in May.

U.S. Treasury yields fell slightly early Friday despite the BoJ’s surprise tweak to its yield-curve control policy. The BoJ’s official 0% target on 10-year government bonds didn’t change, but it now calls the -0.5% to 0.5% range it has in place “reference points,” not “rigid limits.” The BoJ said this would give it “greater flexibility.” Economists said this was the equivalent of Japan raising the cap to 1%, and Japanese stocks declined.

Reports that Japan might make such a decision rattled U.S. stocks on Thursday as spikes across the U.S. Treasury curve seemed to spook investors. Strong U.S. economic data released early on Thursday generated additional pressure, highlighting the need for the Fed to be more aggressive in pushing growth and inflation down if they experience a resurgence, says Kevin Gordon, senior investment strategist at the Schwab Center for Financial Research.

Rising yields typically hurt growth stocks and smaller companies that may depend more on borrowing for future growth. That might explain why the Russell 2000 (RUT) small-cap index fell most dramatically yesterday. Sectors like utilities and real estate, which try to attract investors with dividend yields, also got hit by Thursday’s Treasury yield gains.

Technically, yesterday was an “outside day” on the charts for the S&P 500 Index (SPX), meaning it ventured both above the previous day’s high and below the previous day’s low. This one looked negative in that the SPX reached a peak very early Thursday and then finished sharply below Wednesday’s close, illustrating investor uncertainty. Such a move can sometimes draw technical sellers.

• The 10-year Treasury note yield (TNX) fell 4 basis points to 3.96%.
• The U.S. Dollar Index ($DXY) fell to 101.5.
• Cboe Volatility Index® (VIX) futures dropped to 13.51.
• WTI Crude Oil (/CL) jumped to $80.16 per barrel.

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PCE prices in June rose 0.2% for both the headline and the core numbers, which is in line with Wall Street’s consensus. The core figure showed sequential improvement, falling from May’s 0.3% rise.

The core data, which strips out volatile food and energy costs, is the one the Fed watches most closely. It’s been “sticky” at 4.6% to 4.7% on an annual basis most of the year. Core PCE had been expected to rise 4.2% year-over-year in June, but slowed to just 4.1%, down from 4.6% in May. That’s likely to be seen as progress on the price front, though it remains well above the Fed’s 2% goal. Headline PCE prices rose 3% in June, down from 3.8% in May.

June Personal Income and Personal Spending also hit the tape this morning. Personal spending’s 0.5% climb was more than analysts had expected, perhaps reflecting low unemployment and improving consumer sentiment. The final July University of Michigan Consumer Sentiment report is due out after the open and analysts expect a headline of 72.6, unchanged from the preliminary July report and up from 64.4 in June, according to Trading Economics.

Wage growth was up 0.6% in June—the fastest increase since January. This is a key driver of overall income growth and speaks to resilience of the labor market. The Employment Cost Index saw a 4.5% year-over-year growth rate in June, the fastest on record aside from during the pandemic. This is probably still too hot for the Fed, which has been trying to cool the labor market.

Futures trading indicates a 20% probability that the FOMC will raise rates at its September meeting, according to the CME FedWatch Tool. The probability for November is close to 27%. Those were basically unchanged from yesterday despite today’s data.

In one positive sign the Fed might have noted, the Q2 Gross Domestic Product (GDP) deflator, which measures inflation in the price of goods and services produced in the U.S., fell to a 2.2% annualized rate, the lowest since Q2 2020 and a sign that prices appear to be softening. It peaked at 9% in Q2 2022.

Despite that, Treasury yields rocketed on Thursday following better-than-expected U.S. Q2 GDP growth and anticipation that the BoJ might address its yield-curve control policy, which has kept yields from rising despite growth in the Japanese economy.

The U.S. 10-year Treasury note yield jumped a sharp 14 basis points Thursday to trade above 4% for the first time since July 10 after falling all the way to 3.73% on July 18. The 2-year Treasury note yield, which is more sensitive to the Fed’s rate policy, rose 9 basis points to 4.92%. If Japanese buyers stayed home to invest in their own country’s bonds, it would likely hurt U.S. Treasury prices, sending yields higher (yields move the opposite way of the underlying note’s price).

Rising Treasury yields could also indicate growing fear of another rate hike after the Fed said this week it would take a meeting-by-meeting, data-driven approach to interest rate policy. The futures market still builds in high probability of the Fed pausing in September, with a better chance that it could raise rates another 25 basis points in November. If it does so in either month, rates would reach the Fed’s projected 2023 terminal, or peak, level between 5.5% and 5.75%. They’re already at their loftiest point since 2001.

The earnings car hit a few slippery spots this week. Two notable examples are the market’s disappointment with Microsoft’s (MSFT) cloud market outlook and a selloff of Spotify (NYSE:SPOT) shares after the music streaming company’s earnings miss and weak guidance.

For the most part, however, it’s been a smooth road, highlighted most recently by Intel (NASDAQ:INTC) and Ford (F): Both surpassed Wall Street’s expectations late on Thursday and are getting premarket trading boosts.

Intel was the bigger surprise, posting a quarterly profit when analysts had expected a loss and citing its positive position to capitalize on artificial intelligence (AI) growth. The company’s cost savings plan contributed to the earnings improvement, Intel said in a press release. Like many info tech companies, it has reduced headcount over the last year.

Ford had a mostly strong quarter, but it the huge losses it’s taking on electric vehicles (EVs) continue to raise eyebrows.

Talking technicals: On Thursday, the SPX spent some time above 4,600, a level that marked technical resistance going back 16 months. In early 2022, the SPX tested that point on rally attempts three times following the record high it set near 4,800 soon after the new year began. It failed each time and fell from there. The 4,600 level marks the last resistance below the all-time high, says Nathan Peterson, director of derivatives analysis at the Schwab Center for Financial Research. The first step is registering a close above 4,600 and then monitoring for sustainability above that level in the following days for confirmation.

If Thursday’s sharp retreat is evidence, 4,600 still represents a challenging point for the SPX. It will continue to be an important level to watch on any rally.