Markets are engaging in a tug-of-war over this week's inflation data. While Thursday's cool Producer Price Index (PPI) reading offers some relief from yesterday's CPI-fueled sell-off, the long-term picture of when the Federal Reserve will feel comfortable enough to cut interest rates has become murkier.

BlackRock Global Chief Investment Strategist Wei Li weighs in on how influential earnings season will be for markets (^DJI, ^IXIC, ^GSPC) and the Fed's consensus for 2024 rate cuts.

"Off the back of yesterday's hotter-than-expected CPI print, we think that a June rate cut is perhaps off the table. But this is a Fed that wants to cut rates as we have seen from their rhetoric," Li explains. "We think that the next two inflation prints will be critical in understanding if July is going to be in play because September is cutting it very fine as we get closer to the elections."

For more expert insight and the latest market action, click here to watch this full episode of Morning Brief.

This post was written by Luke Carberry Mogan.

Video Transcript

SEANA SMITH: Speaking of the rebound action that we are seeing here at the Open, you've got the Dow, S&P, and NASDAQ all trading to the upside. Now, the move to the upside here, the gains that we're looking at on your screen, follows yesterday's sell off as investors started to reassess their expectations for the Fed's first rate cut.

To break down what potentially higher for longer could mean for your investment portfolio, we wanna bring in Wei Li, BlackRock Global Chief Investment Strategist here. Wei Li, it's great to have you here. So talk to us just about how you've looked at the data that's come out over the last 24 hours. And if that is at all, if you're reassessing your positions as a result.

WEI LI: Well, CPI has been hotter than expected. But today's PPI offered some relief. But the big picture here is really that we have been seeing upside surprises on inflation from different pockets of the basket for most part of this year now.

And I think markets are really waking up to the fact that we're going to have high for longer in terms of rate environment as a result of the inflationary environment. So off the back of yesterday's hotter-than-expected CPI print, we think that June rate cut is perhaps off the table. But this is a Fed that wants to cut rates, as we have seen from their rhetoric a few times now so far this year.

So we think that the next two inflation prints will be critical in understanding if July is going to be in play because September is really cutting it very fine as we get close to the election. So this is a Fed that wants to cut. But maybe right now, they cannot point to easing inflation pressure as a reason to start cutting, which is why June is perhaps off of the table.

But two cuts are still likely. And that's what we are going with and as it relates to kind of the broader risk asset and investment implication. Actually, now that we have CPI, PPI out of the way, earnings are going to be so critical. So far this year, we have gone from seven cuts at the beginning of the year priced in to two cuts being priced in now.

And earnings have come to the rescue because markets are up year to date, despite the hawkish repricing. So we'll see if earnings will continue to come to the rescue of hawkish repricing, even as the bar has increased as well for earnings.

BRAD SMITH: As business leaders evaluate what you've put forward, what many other strategists and economists have put forward in the probability of two cuts, three cuts this year, how do you believe that the tenor we hear from these CEOs may shift? And what is that core theme that they're gonna all be talking about when it comes to the economy?

WEI LI: Well, when it comes to the economy, as we think about what to expect for this upcoming earnings season and what we can hear from all the CEOs, is that we're picking up this theme, this trend of divergence within the economy itself.

So on the one hand, we're seeing a bit of a fatigue on the consumers' side. And consumers have really been the bright spot for US economy the last 18 months or so. But as their savings buffer, starts to wear thin, we're starting to register some fatigue from the consumers. But at the same time, we're also seeing a bit of a commodity boom, cyclical manufacturing upturn that is coming through in the earnings revision trend as well.

So what is likely going to happen in this upcoming earnings season that is broadly positive by way of expectation is that underneath the hood, we're going to see a bit of a divergence, which is why being selective is very important.

So continue to focus on sectors that have been delivering quality earnings, not just the laggards. As we play, US equity market is key, which is why we continue to like AI. We like energy for a bit of a geopolitical diversification. And health care, we like for better value after the underperformance last year.

SEANA SMITH: Yeah, when it comes to the consensus expectations, it looks like, at least for S&P 500 companies for EPS growth, the estimation is just for around 3.2% growth there. So much of the narrative over the recent weeks has been this rotation, the broadening out that we've started to see within the market and whether or not this quarter's earnings season is going to solidify the fact that trend is going to continue.

And I bring that up because a lot of that's going to be in the guidance of so many of these companies outside of Big Tech. When you talk about those opportunities, kind of going back off of what you were just saying before, do you expect that to be the case this earnings season? And where do you then see that potentially signaling some outperformance?

WEI LI: Well, we do see a bit of a broadening out of earnings forecasts and upgrades as well. So you talked about slightly over 3% for this upcoming earnings season. But more broadly, for the whole of 2024, the expectation is for US equities to deliver 11% earnings growth for this year, which is higher than the historical average of 7%. So expectation is somewhat high.

But if you strip out Magnificent Seven, the expectation for 2024 earnings growth delivery is still, we're looking at 8%, right? So there is broadening out beyond the tech champions, beyond the AI champions. And I think that is important as we think about, how do we implement US equities?

So understanding where the broadening out of the earnings upgrade is appearing is how we want to play the broadening out of the equity markets rally. So we have seen, for example, sectors that have-- that have the potential to benefit from better AI adoption, right, so we're talking about health care. We're talking about industrials that are also seeing a bit of earnings upgrades.

And we're also seeing this cyclical manufacturing, cyclical upturn that is likely going to support the next wave of earnings upgrade, be it industrials and energy. So understanding where earnings are likely going to come from is how we think about broadening out of the rally rather than understanding where the underperformance has been and try to play the catch-up trade based on no fundamental coming through. That's not how we want to play this market at this juncture.

BRAD SMITH: They say time flies when you're having fun. Always fun speaking with you, Wei Li. Thanks so much for taking the time here today, BlackRock Global Chief Investment Strategist. Appreciate it.