US CPI data: Major sell-off or relief rally?

As the latest U.S. Consumer Price Index (CPI) data approaches, Bank of America analysts are weighing the potential market outcomes, suggesting that the data could either trigger a significant sell-off or ignite a relief rally, depending on the inflation figures.

According to Bank of America, their "house view" predicts a "hotter than consensus" CPI increase of +0.25% month-over-month (m/m) for the headline number, which would result in a year-over-year (YoY) rise of +3.1%.

This forecast is slightly above last month's +3% YoY increase. The analysts emphasize that a "soft CPI" could lead to a relief rally, but caution that "a hotter CPI&re-acceleration could be a major downside event."

In their note, Bank of America highlights the importance of this CPI report as a key market catalyst. A hotter-than-expected CPI print could "bring stagflation fears back to the market," potentially leading to a sell-off. The analysts suggest hedging against this risk with SPY puts.

The upcoming CPI data is not just crucial for equities, but also for the Federal Reserve's policy outlook. Bank of America expects headline and core CPI inflation to rise by 0.25% and 0.22% m/m, respectively.

They state that a continued rise in shelter inflation could reinforce the Fed's confidence in the disinflation process, which might influence their decision to implement a 25 basis point rate cut in September and December.

"If shelter inflation posts another 0.3% m/m rise, then the Fed's confidence about disinflation should increase further. We continue to project 25bp rate cuts from the Fed in Sep and Dec," they write.

The bank says that "with July's NFP print, forward economic visibility is still low."

However, the firm concludes by offering derivatives strategies for investors, recommending either "a tail hedge for a hot CPI print" or "a tactical upside trade" to prepare for a potential relief rally.