On Wednesday, August 15, the U.S. released a highly anticipated inflation report, revealing that the year-over-year growth of the Consumer Price Index (CPI) in July hit its lowest level in nearly three years. The data showed that the July CPI rose by 0.2% month-over-month, slightly faster than June's increase, with a year-over-year growth of only 2.9%, marking the lowest level since March 2021. Excluding the more volatile food and energy components, core CPI increased by 3.2%, with a 0.2% month-over-month rise, in line with market expectations.
Despite the cooling inflation data, market expectations for the Federal Reserve’s policy shift in September have remained largely unchanged, with the prevailing view being that the Fed will implement a 25 basis point rate cut in September. As a result, the U.S. dollar index rebounded 0.4% from its intraday low, while COMEX gold prices on the New York Mercantile Exchange plunged more than 1%. All eyes are now on Fed Chairman Jerome Powell’s speech next week, which will be a key focus for the markets.
CPI Report Offers Few Surprises, Market Reaction Muted
The U.S. Bureau of Labor Statistics reported on Wednesday that although the July CPI saw a slight month-over-month increase, the year-over-year growth rate significantly declined, reaching a near three-year low. This trend indicates that inflationary pressures in the U.S. are gradually easing, providing the Fed with more room for future policy adjustments.
However, the market’s response to this CPI report has been relatively muted. Following the recession fears in early August, the market’s attention has shifted more towards growth indicators, with price data that meets or slightly exceeds expectations having limited impact on rate cut expectations.
One notable concern is the renewed increase in rent, which adds uncertainty to the future outlook for prices. David Doyle, head of economics at Macquarie in Canada, noted, "This report is not as favorable for disinflation as June’s, but overall, it reinforces the fact that the trend remains stable. This provides the Fed with further evidence that the inflationary uptick seen in the first quarter was temporary and has now reversed."
Markets Await More Data
Before next month’s Fed decision, the Federal Open Market Committee (FOMC) will receive two key inflation reports, including the Fed’s preferred July Personal Consumption Expenditures (PCE) data and the August CPI report. According to the Cleveland Fed’s Inflation Nowcasting model, core inflation is expected to face continued upward pressure, potentially slowing progress towards the 2% medium-term target.
Economist Lauren Henderson cautioned that while the latest CPI report shows some relief, there are still underlying concerns that warrant further data before drawing conclusions. If inflation risks continue to rise, the possibility of delaying a rate cut to the fourth quarter cannot be ruled out.
Markets Anticipate Powell’s Guidance on Rate Cuts
According to the schedule, the Jackson Hole Global Central Banking Symposium will be held from next Thursday to Saturday. Historically, the Fed has used this platform to announce significant policy framework changes or shifts in stance.
Wall Street widely expects that after signaling earlier this month, Fed Chair Jerome Powell will use this speech to prepare the market for a rate cut in September. The market expects Powell to lean towards a more "proactive" approach to rate cuts, setting the tone for the upcoming monetary easing.
The July non-farm payroll report has raised concerns about a recession, with the next report set to be released on September 6. Analysts noted, "The current Fed is more focused on labor market data rather than inflation data, and the upcoming labor data will determine the extent of the Fed’s rate cuts."
According to the Chicago Mercantile Exchange’s FedWatch tool, investors have largely abandoned bets on a 50 basis point rate cut in September, with the likelihood of a significant rate cut currently at about 40%. Former Kansas City Fed President George also suggested on Wednesday that the traditional 25 basis point model is the most appropriate choice at this stage.
With CPI falling below 3% for the first time in three years, Powell may announce a victory in the fight against inflation at Jackson Hole and attempt to convince the market that a 25 basis point rate cut in September is on the way. If the August employment report is strong, the Fed may cut rates by 25 basis points at each of the three remaining meetings this year. However, if the August employment data continues its recent weak trend, the Fed might implement 50 basis point cuts in both September and November. Should the data indicate a collapse in the labor market, the Fed could slash rates by 200-250 basis points before December.
In conclusion, despite the July CPI data hitting a near three-year low, uncertainty remains over the extent of the Fed’s rate cut in September. Powell’s speech at Jackson Hole next week will be the key focus for the markets, with investors eagerly awaiting further guidance on the future direction of policy.
