Lowest inflation reading in 2 years reported in June CPI, benefiting the stock market.

Inflation drops to lowest level in over two years, benefiting economy and stock market.

In a surprising turn of events, the June CPI report has revealed that inflation has dropped to its lowest level in over two years. This news has brought about positive implications for both the economy and the stock market.

The consumer price index only rose by 0.2% in June, falling below economists' expectations of a 0.3% increase. On a year-over-year basis, it increased by just 3%, marking its lowest level since March 2021 and falling below estimates of a 3.1% gain.

Investors welcomed this unexpected drop in inflation, leading to a surge in the Dow Jones, Nasdaq 100, and S&P 500, all of which saw gains of about 1%.

Fundstrat's Tom Lee, who accurately predicted a 100 point rally in the S&P 500 due to better-than-expected inflation readings, now suggests that this rally may be on the low end. He believes that the index could potentially experience a gain of over 200 points, propelling it to new 52-week highs.

Lee highlights that in the past, positive reactions to lower inflation readings have resulted in significant market rallies. He notes that out of the last 8 CPI reports, markets reacted positively 6 times, with rallies ranging from 4% to 5% or 180 to 225 points. Based on this, he suggests that the initial 100 point rally prediction may be conservative.

The positive response to lower inflation readings stems from the belief that it supports the notion of a soft landing scenario for the economy. Despite the Federal Reserve's aggressive monetary tightening over the past year, a recession is expected to be avoided. This outlook is further bolstered by the low inflation reading, which gives the Fed more flexibility in its interest rate decisions. Currently, the market is pricing in only one more interest rate hike for the year, whereas previously, it had anticipated two more hikes.

Lower inflation is particularly beneficial for consumers as it allows wage growth to outpace rising prices. This results in real income growth and increased spending power for consumers, which in turn drives the majority of the US economy.

Lee predicts that June's low inflation reading will persist throughout the summer. This could further strengthen the confidence of bullish investors who believe in the resilience of the economy.

"If this CPI print is +0.20% or so, the odds are very high that we will see +0.20% Core CPI prints for each of July and August. That would make three consecutive months where Core inflation is running at 2.0% to 2.5% and would make markets entirely rethink that path of future inflation," Lee explains. "It really raises the question whether 'higher for longer' [interest rates] makes sense."

Overall, the recent drop in inflation has brought about positive implications for both the economy and the stock market. It has emboldened investors, provided the Fed with more flexibility, and given consumers increased spending power. The outlook for the coming months remains optimistic, with expectations of continued low inflation and a resilient economy.

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