Last week came the first of two consumer price index reports that we at Cornerstone consider to be of the utmost importance. They’re important because we continue to navigate the fine line between projecting Federal Reserve rate decision expectations and data that could provide further clarity regarding any potential tariff effects on inflation.
Typically, more data is better because it can bring more clarity. And this is what we want because the June CPI report has been forecasted by “bad news bears” and market pundits as the bellwether for disastrous inflation brought on by tariffs.
While the initial equity market reaction to last week's CPI print was negative though muted, when looking deeper into the report, it’s just fine if that’s the bad news:
While overall inflation in June increased 2.7% from a year ago, core CPI (excluding energy and food prices) once again came in better than expected:
Digging further, the initial equity market response may have been an emotional overreaction. Here’s why.
After more research, to us it became clear that much of the increase in inflation can be blamed on many businesses trying to front run tariffs by loading up on inventory. But since it’s now clear that some level of tariffs are likely here to stay, businesses are going to slow down purchases alongside consumers in a typical dynamic supply/demand curve.
It’s already starting play out in the auto sector. Surprisingly sticky used car and truck prices suddenly fell 0.7% from a month ago. This is a sign of the market cooling as consumers already loaded up on auto purchases a couple months ago.
This is further reflected in the fact that the biggest change in core CPI was commodities, which flipped from negative to positive:
That is likely because of the load up on inventories. And it’s clear from digging into June CPI details, a few main contributors from the commodity group drove most of the month’s inflation gains:
So, now you may ask why we’re not too worried. It’s because even with inventory commodity front loading, overall core prices only rose 0.2% month-to-month, which was below expectations. That means many other categories are continuing to cool seemingly at a rate faster than any significant impact from tariff-related price increases.
We’re not dismissing all tariff-related concerns – they could still seep into inflation. However, the data clearly shows that being overly concerned isn’t prudent unless a trend emerges. As of the June data, a trend hasn’t emerged.
Underappreciated Macro Tailwinds
After unpacking the all-important data above, let’s turn to a few underappreciated macro tailwinds for equity markets that are already in motion and do not appear to be ending soon. That’s true even as the bear-istas worry list continues to grow even longer than usual, causing many to miss the forest for the trees.
Better than Feared
We keep being surprised at how skeptical much of the crowd is in the face of record equity prices. We think the biggest reason for this is that many people miss the fact that stocks don't trade on good or bad, they trade on better or worse.
The macro environment isn't perfect. But we can effectively agree that it's a lot better than it was three months ago when markets discounted an extraordinarily dire scenario.
We've seen once again that equity markets can recover quickly if reality turns out to be better than feared, as has been the case:
As the chart above shows, economic policy uncertainty began to recede as stocks began to climb to new heights.
Tariff Risk Surprise to the Downside
We’d argue there may be no better example of the uncertainty reversal than what’s taken place with trade policies since early April.
It’s important to acknowledge that the current 10%-15% effective tariff rate is much higher than 2024’s 3% rate. It’s also important to acknowledge that the current rate is much lower than the 28% effective rate that the market priced in back in April:
This decrease in effective tariff rate expectations has allowed markets to see through the fear, not because it's gone, but because it's likely to be much better than initially feared.
Rate Cuts Seemingly Delayed, But Not Denied
Continuing our theme for the day, it's reasonable to argue that monetary policy is another example of reality turning out to be better than originally expected. While the Fed made it clear tariff-related certainty must be had before rates are cut, the central bank also left the door more than ajar for cuts in the second half of this year.
As discussed above, the fact that the CPI report shows that inflation is holding better than expected only further suggests a runaway for the Fed to get back to a rate cutting policy. But you don't have to take our word for it. Simply look at the bond market, which appears to agree with this sentiment.
The two-year Treasury yield historically acts as a proxy for anticipated Fed policy because Fed policy controls the short end of the curve, not the long end. As you can see, the two-year yield fell to around 3.87% from 4.35% in February:
This is a reliable historical signal of an increasing likelihood that the Fed will cut interest rates sooner rather than later. As we all know, once the Fed actually signals it's ready to ease, it will be a bullish tailwind for stocks well into 2026.
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