US stocks encountered another incentive to proceed with caution ahead of next week's US inflation report. Compounding the wary sentiment, investors grappled with a sobering reality: a notable decline in US consumer sentiment amid escalating inflation expectations, spotlighted by the latest Michigan Consumer Sentiment Index.

The preliminary reading from the University of Michigan sentiment index showed a sharp decline, with consumer sentiment dropping to a concerning 67.4. This marked a notable 10-point decline and a substantial miss compared to the expected reading of 76.2. This drop is the most significant since June 2022, coinciding with the Federal Reserve's implementation of upsized rate hikes, partly in response to heightened medium-term inflation expectations revealed in the Michigan release.

Survey director Joanne Hsu underscored the seriousness of this decline, highlighting that it brings sentiment to its lowest level in about six months. The deteriorating mood was pervasive across various demographic groups, with Americans expressing a broad consensus in perceiving negative developments across multiple fronts.

A primary concern among consumers is inflation, with year-ahead expectations surging to 3.5% from 3.2% in April, marking the second consecutive 0.3-point increase. Longer-term inflation expectations also rose, reaching 3.1%, at the upper end of the post-pandemic range.

Friday's release follows a lacklustre report on Conference Board confidence, further emphasizing the prevailing sense of pessimism among consumers. While some may argue that the deteriorating sentiment increases the likelihood of rate cuts, especially given softer labour market data and contractionary ISM prints, the primary driver of consumer concern being inflation makes advocating for rate cuts based on the consumer's sombre mood akin to fitting a square peg in a round hole.

Next week holds significant importance for financial markets and forecasters alike. With the release of fresh Consumer Price Index (CPI) and Producer Price Index (PPI) reports for April, along with new readings on April retail sales and industrial production, traders will have the opportunity to recalibrate their forecasts for real GDP and consumer spending growth in the second quarter.

These data releases will also offer valuable insights into the current inflationary environment, which will play a crucial role in shaping expectations regarding Federal Reserve rate cuts and longer-term interest rates for the remainder of the year

Not to be outdone, April retail sales and industrial production figures will provide crucial indicators of consumer and industrial activity, shedding light on the strength of the economic landscape and the resilience of various sectors in the face of higher for longer interest rates.

The upcoming data releases hold the promise of shedding light on a crucial question: Is the economic activity recorded in the second quarter genuine growth or merely a reflection of inflationary pressures?

Currently, GDP trackers from the Atlanta Fed and New York Fed present divergent narratives about the strength of the real economy. The Atlanta Fed's GDPNow forecast for Q2 has surged to a robust 4.18% annualized rate this week, while the New York Fed's Nowcast slipped to 2.23%. Mind you both estimates surpass most super forecaster expectations, suggesting there are varying perceptions of economic reality on Wall Street

However, the rapid ascent of consumer prices is eroding consumer spending power. Recent months have witnessed significant price hikes in retail gasoline and other commodities, signalling another potentially "hot" reading on monthly consumer inflation. Additionally, the ISM Manufacturing and ISM Services prices-paid indexes saw substantial increases in April, indicating a resurgence of inflationary pressures. And worryingly, consumers' one-year inflation expectations have trended upward, reaching 3.5% in May from 3.2% in April and 2.9% in March, as per the University of Michigan Consumer Sentiment Survey.

All eyes will be on the CPI inflation data for April, set to be released on Wednesday. The super forecasters I follow anticipate a 0.4% increase in the headline measure for the third consecutive month, with a slight slowdown in the core measure to 0.3%. Despite expectations for headline and core inflation to moderate to 3.4% and 3.6%, respectively, compared to a year ago, this is largely attributed to favourable base effects from the previous year.

Navigating such an environment, characterized by dwindling sentiment alongside persistent inflationary pressures, feels akin to traversing through economic sludge. Should the ominous term "STAGFLATION" echo through the crowded Index room next week, it may trigger a rush for the exits

The caveat is that while inflation may come in hotter than expected, it's unlikely to reach the threshold that would trigger another round of rate hikes. However, stubbornly high consumer inflation is expected to keep the Fed on hold and maintain a "data-dependent" approach throughout the summer and into the fall. This will keep mind games alive all summer! 

That will be a curtain call to check out for the summer !!

Next week, I've committed to participating in a TV panel discussion for CGTN, the English-language news channel of China Global Television Network, headquartered in Beijing, China. The topic is USDJPY, and I'm looking forward to contributing to the conversation. then after that, I will limit my market commentary updates until September. My primary focus will be on long-distance running to fully pursue and embrace health, fitness, and wellness goals.

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