S&P 500 Rally Hits a Wall at End of Banner Quarter

Earlier in the session, traders kept a close eye on economic data.

U.S. consumer sentiment declined by less than initially estimated on expectations inflationary pressures will moderate. The Fed's preferred measure of underlying U.S. inflation decelerated. Household spending rebounded and incomes showed solid growth, offering some hope that price pressures can be tamed without lasting damage to consumers.

"From the market's perspective, today's PCE report was near perfect," said David Donabedian at CIBC Private Wealth U.S.. "The Fed's favorite inflation indicator not only showed inflation was moving towards the Fed's inflation target, but that the economy is resilient. Consumer spending was on the rise and take-home pay was also up after a couple of sluggish months."

Softening in the measure of inflation favored by the Fed highlights a slowing economy that's upping the risk of a policy error by the central bank, Mohamed El-Erian said.

"The economy is slowing faster than most economists expect and faster than what the Fed expected," El-Erian, the president of Queens' College, Cambridge and a Bloomberg Opinion columnist, told Bloomberg Television on Friday.

To Seema Shah at Principal Asset Management, while the inflation data is a relief and will be welcomed by the Fed, the policy path is not yet certain.

"A further deceleration in inflation, ideally coupled with additional evidence of labor market softening, will be necessary to pave the way for a first rate cut in September," she noted.

Fed Bank of San Francisco President Mary Daly told CNBC said the latest inflation data indicates monetary policy is working, but said it's too early to tell when it will be appropriate to lower borrowing costs.

Earlier Friday, her Richmond counterpart Thomas Barkin said the inflation battle still hasn't been won, and the U.S. economy is likely to remain resilient as long as unemployment remains low and asset valuations high.

"The soft inflation data will build the case that the Fed can start cutting rates in the coming months," said Jeffrey Roach at LPL Financial. "As long as incomes grow at a healthy clip, consumers will keep spending. The key is the labor market and so now, we should shift our attention to next week's nonfarm payroll release for a fresh look into the job market."

The timing of the first rate cut matters because bonds rally in anticipation of that cut, according to Joe Kalish at Ned Davis Research.

"Any second half bond market outlook is contingent on Fed policy," he said. "The timing of the first rate cut has historically been important for the bond market, as yields tend to peak 2-3 months before the first rate cut."

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