Today’s US CPI data release is likely to be the most important for the whole week, in light of what happened to the markets last week. The most recent drop (and so far tepid recovery) was driven primarily around the outlook for the US economy. Markets are now pricing in a lot more rate cuts than the Fed is acknowledging as a possibility.
The US CPI data coming up will be a test of the two theories. If inflation comes in hotter than anticipated, it could fuel a reversal in market sentiment. For now, markets are hoping that the Fed will take to easing aggressively after September. But if CPI is changing at a high rate, then the Fed likely can’t do much easing. While that would likely lead to the stock market recovery fizzing out, it could also support the dollar.
Not Enough Tightening?
One of the problems that the Fed is facing is the “stickiness” of inflation for about a year now. When the Fed started raising rates in 2022, inflation started to come down. By the time the Fed ended its rate hiking spree in July of 2023, inflation was almost down to target, hovering at just above 3.0%. And inflation is still there. It could suggest that the Fed might have ended its hiking cycle a little too early, which has contributed to keeping it too high for too long.
Overly restrictive monetary policy can contribute to a recession forming, which is one of the reasons why markets were particularly worried at the start of this month. So, inflation moving below that 3.0% floor would likely come as a substantial relief to markets that things are finally going in the right direction.
The Data Point That Matters
While headline inflation came down rather quickly, in large part thanks to falling fuel prices, the key core rate has been much slower to move towards target. Core inflation doesn’t have to reach 2.0% for the Fed to start easing, rather the expectation is that if all indicators are trending lower, then the expectation is that they will continue in that direction. Particularly if there is a slight slowdown in economic activity, which typically correlates with lower inflation. Then the Fed can pull the trigger in September, as is universally expected to happen.
Economists generally believe that headline inflation will remain stable, with core inflation moving lower. This has been the theme for months now, which has left the Fed saying one cut for this year. And markets have variously moved towards expecting more cuts, only to be brought back to reality by the data and commentary from FOMC officials. Let’s see if the data later today will repeat the pattern.
What to Look Out For
Headline US CPI data for July change is expected to remain steady at 3.0%, above the 2.0% Fed target. That’s thanks to a pick up in monthly inflation to 0.2% from -0.1% prior, with higher fuel prices being the focus. The core inflation rate is also expected to come in unchanged at 3.3%, with analysts pointing to the monthly rate popping up 0.3% from 0.1% with a focus on shelter costs.
The Fed cares more about the core rate. So, even if the headline ticks up a bit, as long as the core rate shows a downward tendency, the market is likely to be happy. But a mere one decimal uptick in the core could end up upsetting traders, particularly given how skittish the market seems lately.