Fed Chairman Powell made a major hint this week about the Fed's plan to end the longest period of tightening since records began, but the hint had nothing to do with the inflation path.

For most of the past four months, US stocks have been rising, setting a series of record highs and extending the year-to-date gains of the S&P 500 index to around 17%. These exciting returns are built on the huge profits of large technology companies, improving corporate profits, and bets on the Fed's rate cuts in autumn.

In the post-COVID era, US inflation has soared, and the Fed has raised its benchmark interest rate to around 5.375%, a 22-year high. The last time a rate hike was in nearly a year ago when the overall inflation rate was 3.2%.

Since then, inflationary pressures have been difficult to control, frustrating. In November last year, the maximum interest rate rose to 3.7%, and in January this year, it dropped to 3.1%, both of which were much higher than the Fed's preferred target of 2%.

Economists predict that CPI data to be released on Thursday will show that June's overall CPI year-on-year growth rate will be recorded at 3.1%, which is not much different from the previous value; the year-on-year growth rate of core prices is expected to be about 3.4%, roughly the same as the May level.

This may not be enough to send a signal to the Fed to cut rates in the near term, especially considering that the Fed warned that the so-called base effect may bring small rebound pressure on inflation in the second half of the year.

The subtle shift of the Fed's focus on inflation

Fed Chairman Powell skillfully shifted the market's focus from stubborn inflation data to recent weakness in the job market, indicating that this may be the key to the Fed's next interest rate move.

Powell told senators on Tuesday, "Rising inflation is not the only risk we face. The latest data shows that the condition of the labor market has cooled significantly from two years ago."

The US Department of Labor reported last week that about 0.206 million jobs were added in the United States last month, which was better than expected, bringing the total number of jobs in 2024 to about 1.4 million. However, earlier data was revised downward, and the overall unemployment rate surpassed 4% for the first time in more than two years.

The economy is facing two-sided risks

Wider economic growth is also slowing, with the Atlanta Fed's GDPNow tool showing that second-quarter GDP growth is about 1.5%, only slightly higher than the 1.3% increase in the first three months of this year.

Taking into account this slowdown, Powell told senators that the economy is facing "two-sided risks", both of which are related to the Fed's decision.

"If we relax policy too late or too little, we could damage economic activity. If we relax too quickly or too much, then we could undermine progress on inflation. So, we're balancing those two risks to a large extent," Powell said.

This may make the next round of job market data, including the Jolts report in June, non-farm employment data in July, and the challenger business layoffs data the focus of the market, and put inflation data in second place in the coming months.

Lauren Goodwin, economist and chief market strategists at New York Life Investments, said:

"After focusing on inflation for two years, the Fed is talking more about the labor market and acknowledging that any unexpected weakness in the labor market may prompt them to cut rates faster. But what we're seeing today isn't an unexpected weakness in the labor market, everything is fine, and we believe the Fed can cut rates as early as September, and we believe the Fed will pay attention to the reason for the shift at that time."

Jackson Hole Central Bankers Meeting may be a key

The Fed will hold an FOMC meeting on July 31 and announce its latest rate decision. Most market participants expect the Fed to continue to hold steady and keep the federal funds rate between 5.25% and 5.5%.

However, the next major event, the Jackson Hole Central Bankers Meeting, may provide the clearest indication to the market that the Fed is likely to cut rates in September, with the CME Group's Fed Watching Tool showing a 74% chance of a 25 basis point rate cut in September.

Powell will deliver a keynote speech at the meeting and will also receive employment data and inflation reports for July.

Ian Shepherdson of Pantheon Macroeconomics said, "We still believe that the Fed has waited too long and will soon be eager to prevent a major recession. We expect Powell to send a clear signal at the Jackson Hole Central Bank Annual Meeting in late August that interest rates need to be cut at least once this year."

However, this may still disappoint the market as traders expect the Fed to cut interest rates at least twice this year and multiple times in 2025. Rate cuts will support a stock market rebound, pushing the S&P 500 index close to the 6,000-point mark. After reaching 36 record highs this year, the stock market may also enter what Scott Rubner of Goldman Sachs calls a "correction state." In a report released this week, Rubner notes that stock market liquidity in August is usually the slowest of the year and that the stock market has historically fallen from mid-July highs. If this earnings season is disappointing, investors will begin to focus on the results of the U.S. presidential election. Generally speaking, a correction is defined as falling at least 10%. LSEG data shows that total profits for S&P 500 index component companies are expected to grow 10.1% from the same period last year to $492.8 billion, about $5 billion lower than previous forecasts. Analysts expect full-year profits to grow 10.6% and further increase by 14.5% in 2025. Rubner said:

After the S&P 500 index hit 36 record highs this year, it may also enter what Scott Rubner of Goldman Sachs calls a "correction state."

Rubner notes that August stock market liquidity is usually the slowest of the year and that the stock market has historically fallen from mid-July highs. If this earnings season is disappointing, investors will begin to focus on the results of the U.S. presidential election.

Generally, a correction is defined as a drop of at least 10%. LSEG data shows that total profits for S&P 500 index component companies are expected to grow 10.1% from the same period last year to $492.8 billion, about $5 billion lower than previous forecasts. Analysts expect full-year profits to grow 10.6% and further increase by 14.5% in 2025. Rubner said:

"The painful trade has turned downward, and after the best trading day of the year, buyers are already fully loaded, and ammunition is running out."