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Yesterday (12 August), inflation data from the US came out lower than expected at 2.7%. This helped to trigger the S&P 500 to rally, trading back above 6,400 points. Upon closer examination of the data release, signs suggest we may be nearing further interest rate cuts from the Federal Reserve, which could serve as a catalyst for a broader market move higher.
Inflation details
The headline rate of inflation in the US has been rising since April, which has caused some investors to be concerned that interest rates might have to stay higher for longer. Normally, this isn’t a great sign for stocks. Companies often rely on debt and funding to function, so the interest costs associated with this would weigh on profits.
However, the 2.7% reading was the same as June. This potentially indicates that the period of higher inflation is coming to a close. Importantly, it also didn’t show any real impact from tariffs. Analysts were expecting any tariff impact to start to appear in the data series. The fact that it hasn’t is confidence-boosting for investors.
Based on this information, the probability of an interest rate cut at the September Federal Reserve meeting has risen. It looks like people are now expecting action from the central bank which, if realised, would be another positive sign for the stock market.
Targeting specific areas
It’s true that if the above plays out, the S&P 500 could have plenty of juice to move higher. Yet I think it’s wise to be active in stock selection right now, instead of just buying an index tracker. This is because specific sectors will benefit a lot more from interest rate cuts than others. This includes property, tech and utilities.
At a specific stock level, I can identify some good ones, including PayPal (NASDAQ:PYPL). The global digital payments platform facilitates online money transfers and payment processing for consumers and merchants. PayPal earns money primarily from transaction fees charged to merchants, as well as from value-added services like foreign exchange spreads and interest on customer balances.
Lower interest rates can benefit PayPal in several ways. First, cheaper borrowing costs can stimulate consumer spending and e-commerce activity. This should directly increase the transaction volumes flowing through its ecosystem.
Further, lower rates tend to ease credit conditions for merchants, which can boost small business activity and online sales, driving more payment processing revenue. It’s also important to remember that the business offers some credit-related products. Reduced funding costs improve margins and can spur demand as people can more easily afford credit.
The stock is up 6% over the past year. However, there are still risks involved. The online payment space is very competitive, with other companies realising the revenue potential from retail customers. PayPal needs to remain alert, otherwise, it could quickly get left behind.
Even with this, I think it’s well set to benefit from falling interest rates if inflation doesn’t rise. Therefore, investors could consider it for their portfolios.
