(Bloomberg) — Wall Street traders betting the Federal Reserve will be able to cut interest rates soon sent bond yields tumbling — while driving a strong stock-market rotation.

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Further signs that inflation is slowing down fueled speculation the Fed will be able to move as early as September. Optimism over lower rates sparked a shift into riskier corners — as money exited the long-favored safety trade of technology megacaps. The Russell 2000 of smaller firms beat the Nasdaq 100 by 5.5 percentage points — the most since November 2020. While the S&P 500 fell 1%, almost 400 of its shares were up.

To Callie Cox at Ritholtz Wealth Management, today could be a turning point for markets. It’s also a good reminder that diversifying is important.

“The big tech trade is turning on itself, yet the rest of the market is finally stepping in,” Cox said. “The S&P 500 is down today, but this is the best kind of selloff you could hope for if you’re a long-term investor.”

The S&P 500 fell to 5,580. The Nasdaq 100 sank over 2%. A Bloomberg gauge of the “Magnificent Seven” megacaps headed toward its biggest loss since July 2023. Tesla Inc. sank 7% on news it’s postponing its planned robotaxi unveiling to October. The Russell 2000 climbed 3.5% — set for its best day in 2024. Banks rose ahead of the start of the earnings season.

US 10-year yields dropped nine basis points to 4.20%. The dollar headed toward its biggest drop since May. Japan’s currency chief stuck with his strategy of trying to keep market players in the dark over whether Tokyo stepped in to prop up the yen after sharp moves.

To Dan Wantrobski at Janney Montgomery Scott, the big move on the Russell showcases a notable improvement in overall breadth/participation.

“This fanning out from the narrow leadership areas (Mag 7/AI/megacap) throughout much of this year is what we would like to see continue over the coming weeks and months in order to confirm a healthier expansion cycle on a longer-term basis,” he added.

It’s a pretty swift reversal in the momentum trade, and that tends to benefit the laggards to a significant degree, according to Kevin Gordon at Charles Schwab.

“No question it’s in response to the fact that the prospect of rate cuts helps companies that have been struggling in the ‘higher for longer environment.’”

US inflation cooled broadly in June to the slowest pace since 2021 on the back of a long-awaited slowdown in housing costs, sending the strongest signal yet that the Fed can cut rates soon. Fed Bank of San Francisco President Mary Daly said given recent data on employment and inflation, some adjustment to rates will likely be warranted — though she stopped short of offering a specific timeline for cuts.

“Sticky inflation is coming unglued,” said Michael Feroli at JPMorgan Chase & Co. “We now think this paves the way for a first cut in September (previously November), followed by quarterly cuts thereafter.”

To Chris Larkin at E*Trade from Morgan Stanley, July is still a longshot, but Thursday’s “Fed-friendly CPI” got markets one step closer to a September rate cut.

“A lingering question is whether this high-flying stock market has already priced in multiple cuts.”

Investors are growing increasingly concerned that US technology megacaps are spending too much on artificial intelligence, according Goldman Sachs Group Inc. strategists.

Companies that the strategists refer to as “hyperscalers” — including Amazon.com Inc., Meta Platforms Inc., Microsoft Corp. and Alphabet Inc. — have utilized about $357 billion for capital expenditure as well as research and development in the past year, the team led by Ryan Hammond said.

“Today’s hyperscalers will eventually be required to prove that revenues and earnings will be generated from their investments,” Hammond wrote in a note. “Early signs that may not be generated, could lead to valuation de-rating.”

Meantime, Neuberger Berman Group’s Steve Eisman expects the outsized strength in US megacap technology shares will “last for years,” as AI becomes more accessible to consumers via electronic devices.

People will want new AI apps on cellphones and personal computers, spurring the “biggest refresh cycle in history” as they purchase upgraded gadgets, he told Bloomberg Television in an interview on Thursday.

Wall Street’s Reaction to CPI:

  • Neil Dutta at Renaissance Macro Research:

The doves have what they need. It is time to cut.

  • George Mateyo at Key Wealth:

We’ll see you September! Better-than-expected inflation readings in many key sectors should allow the Fed to start talking about adjusting policy in July — and potentially allow the Fed to act in September.

That said, we still see the Fed wanting to gain further confidence before cutting aggressively unless stress materializes in the labor market.

  • Skyler Weinand at Regan Capital:

With another good CPI print under their belt, the window is open for the Federal Reserve to cut interest rates as early as September, and potentially again in December, assuming the inflation data continues to cooperate.

The Fed is in a tug of war with the Treasury, which is spending lots of money and arguably adding to inflation. At the current pace of the inflation slowdown, it may be 6-8 months before we get to the mystical 2% inflation target the Fed is waiting for.

  • Richard Flynn at Charles Schwab UK:

Today’s figures show that the rate of inflation has dropped, compared to last month. This is the latest in a string of data releases that continues to set the stage for the Fed to cut interest rates this year, potentially as soon as September. We expect that this economic optimism will benefit markets.

  • Ron Temple at Lazard:

A September rate cut should be a done deal at this point. Given the increasing evidence of slowing economic growth, it’s time for the Fed to refocus on the dual mandate and ease monetary policy.

  • Jason Pride at Glenmede:

These CPI reports are like a tic-tac-toe board, two in a row isn’t enough to claim victory, but it is a significant step forward after a years-long unrelenting inflation force.

The FOMC meeting in September is probably truly “live” in the sense that rate cuts are on the table for serious consideration, setting up the potential for the Fed to cut at each of its three meetings to close out the year, as easing inflation allows it to focus on both sides of its dual mandate.

  • Jay Hatfield at Infrastructure Capital Advisors:

The cool inflation print, combined with a weakening economy and labor market, indicates that the Fed should cut in July, but probably won’t due to its flawed policy framework and propensity to be behind the curve. We do believe that the Fed will definitely cut by September.

The September Fed cut will usher in a wave of continued central bank cuts which will require a large injection of liquidity into the global banking system. Historically, large injections of liquidity cause rallies in both stocks and bonds.

  • Greg McBride at Bankrate:

With abundant signs of a cooling economy, the Consumer Price Index for June certainly constitutes the “more good data” on inflation that Fed Chair Jerome Powell has said we need to see before the Fed can begin cutting interest rates.

This aligns with a September interest rate cut.

  • Peter Boockvar at The Boock Report:

Inflation continues to moderate. September cut is a lock I believe.

I’ll argue again though, the battle with inflation is being won but the outcome of the war is yet to be determined and will only be when we have a sustained period of low inflation.

  • Jamie Cox at Harris Financial Group:

The inflation fight is entering a new phase as the data clearly demonstrate — the economy is cooling and so is inflation.

With a major deficit fight looming in 2025, chances are the Fed will have to be more aggressive than folks currently appreciate.

  • Chris Low at FHN Financial:

The Fed will be very pleased with the June CPI report. In fact, inflation was so subdued, FOMC members may start to worry they have kept policy tight for too long.

A 10 basis-point drop in 10-year yields suggest bond traders are not just expecting quick cuts, they are starting to price in more cuts, too.

  • Andrew Brenner at NatAlliance Securities:

This will not make July viable — but September looks likely. But beware we still have to bid on a long bond.

  • John Kerschner at Janus Henderson:

Given that the next Federal Reserve meeting is less than three weeks away, the market is currently pricing in that the Federal Reserve will skip that meeting and make their first cut in September.

Maybe more importantly, the market is now expecting three cuts by the end of January 2025. Chair Powell recently said that the risks towards inflation are now more “balanced.” Today’s number reinforces that view and perhaps now tilts the scale towards concerns of a sharper slowdown in the US economy.

  • David Russell at TradeStation:

Given rising inventories in housing, this sizeable component of the price index is finally starting to give the Fed what it needs to see for rate cuts. Goldilocks is here and a September cut looks more likely than ever.

  • Bryce Doty at Sit Investment Associates:

Our base case is still a half point cut in December but we now think there is a decent chance for a September cut.

The belly of the curve will benefit the most. We really like the 5-year here.

  • Bret Kenwell at eToro:

When combined with the recent weakness we’ve seen in the labor market, this likely has the Fed readying a rate cut. Some investors may be wondering if a July cut could be in the cards. While that may be too soon for the Fed, a September cut should be the base-case expectation.

Energy and goods both weighed on the CPI results, while the stickier services component has finally started to cool a bit. If this trend continues, it certainly points to lower rates from the Fed, which is still trying to orchestrate a soft landing.

  • John Lynch at Comerica Wealth Management:

Since the federal funds rate (5.25%-5.00%) remains above nominal GDP growth of approximately 5.0%, we look for two cuts in the coming months to ensure monetary policy gets less restrictive. Beyond that, however, investors should be careful what they wish for…if the Fed cuts much beyond that, it will be because the Fed HAS to cut! That is not an environment conducive for economic or market growth.

  • Kurt Rankin at PNC:

The June 2024 CPI result brings a September 2024 Fed Funds rate cut into the picture.

Commentary from Fed officials should soon begin leaning toward optimism that their goal of an average 2.0% pace of consumer price growth is attainable, as opposed to recent rhetoric that has been ever wary of risks and pitfalls along the road ahead. And if a few more months’ worth of inflation’s current downward trend can be secured, actions on interest rates will surely follow that rosier talk.

  • Paul Ashworth at Capital Economics:

CPI qualifies as “more good data.”

With Fed officials also apparently getting a little more nervous about labour market weakness, it does strengthen the case for a September rate cut.

  • Lindsay Rosner at Goldman Sachs Asset Management:

One word: pivotal.

With three inflation prints between this morning and September’s Fed meeting, today’s print was crucial in helping the Fed gain confidence inflation is still moving in the right direction.

  • Quincy Krosby at LPL Financial:

Cool CPI puts a September rate cut clearly in play.

For the market, clearly the preferred basis for easing rates is predicated on inflationary pressures cooling at a steady pace rather than on an economy losing momentum.

Corporate Highlights:

  • Bunge Global SA’s $8 billion deal to acquire Glencore Plc-backed Viterra is facing the risk of delays as countries including Canada, China and the European Union are yet to approve the acquisition.

  • Delta Air Lines Inc. warned that domestic carriers are struggling to fill planes in the all-important summer travel season, dragging down ticket prices in a fare war that’s weighing on profits.

  • Pfizer Inc. is moving forward with a weight-loss pill as it seeks to mount a comeback from its post-pandemic slump, but the drugmaker gave few clues about what exactly informed that decision.

  • Apple Inc. has avoided the threat of fines from European Union regulators by agreeing to open up its mobile wallet technology to other providers free of charge for a decade.

  • Costco Wholesale Corp. is boosting its membership fees for the first time since 2017, raising the charge for a basic membership to $65 a year from $60.

  • Royal Bank of Canada is shuffling its leadership ranks and breaking its largest division into two, in one of the biggest reorganizations of Dave McKay’s decade-long tenure as chief executive officer.

  • Tata Consultancy Services Ltd. reported profit that topped analysts’ estimates, signaling corporations are resuming spending on projects to take advantage of technologies such as artificial intelligence.

Key events this week:

  • China trade, Friday

  • University of Michigan consumer sentiment, US PPI, Friday

  • Citigroup, JPMorgan and Wells Fargo’s earnings, Friday

Some of the main moves in markets:

Stocks

  • The S&P 500 fell 1% as of 1:48 p.m. New York time

  • The Nasdaq 100 fell 2.3%

  • The Dow Jones Industrial Average was little changed

  • The MSCI World Index fell 0.3%

Currencies

  • The Bloomberg Dollar Spot Index fell 0.5%

  • The euro rose 0.3% to $1.0861

  • The British pound rose 0.4% to $1.2901

  • The Japanese yen rose 1.8% to 158.77 per dollar

Cryptocurrencies

  • Bitcoin rose 0.8% to $57,842.4

  • Ether rose 1.2% to $3,132.55

Bonds

  • The yield on 10-year Treasuries declined nine basis points to 4.20%

  • Germany’s 10-year yield declined seven basis points to 2.46%

  • Britain’s 10-year yield declined five basis points to 4.07%

Commodities

  • West Texas Intermediate crude rose 0.6% to $82.56 a barrel

  • Spot gold rose 1.8% to $2,413.51 an ounce

This story was produced with the assistance of Bloomberg Automation.

–With assistance from Lu Wang, Sagarika Jaisinghani, Alexandra Semenova, Felice Maranz, Carly Wanna and Henry Ren.

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