Tuesday's news on US data is bullish for inflation, and investors hope the situation will improve on Wednesday when the labor department releases the July Consumer Price Index (CPI) report.

If tonight's CPI data is similarly favorable, it will confirm whether early-year price surges were a fluke or the last gasp of inflation, potentially meaning that the Federal Reserve can redirect its attention to other economic challenges, such as labor market slowdowns.

"At present, we see visible dissipation of inflationary pressure," said Jim Baird, chief investment officer at Plante Moran Financial Advisors. "Inflation is hardly a problem now, and people generally believe that the worst period is over." Like other Wall Street investors, Baird expects the Federal Reserve to shift from a tight policy of fighting inflation in September to a more relaxed stance, in case of a potential weakening of employment.

Despite consumers and business owners continuing to be concerned about high prices, the trend has indeed shifted. The July Producer Price Index (PPI) report released on Tuesday helped confirm the optimistic sentiment, that the high inflation numbers that soared beginning in 2021 and again at the beginning of 2024 have become the past.

The PPI report is viewed as an indicator of wholesale inflation, showing that prices rose only 0.2% in July, about 2.2% higher year-on-year. That number is now very close to the Federal Reserve's 2% target and indicates that the desire to begin lowering interest rates is in line with expectations.

Economists surveyed by the Dow Jones expect CPI to show a month-on-month increase of 0.2% for both total and core inflation (excluding food and energy), with a 12-month growth rate expected to be 3% and 3.2% -- far lower than their peak in the mid-2022s but still far from the Fed's 2% target.

However, investors are still anticipating that the Federal Reserve will begin lowering interest rates at its September meeting, given weakening inflation and labor market conditions. The unemployment rate has risen to 4.3%, up 0.8 percentage points from the same period last year, triggering a classic recessionary signal known as the "Samuelson Rule."

Baird said:"Given the relative softness of labor markets, given the fact that inflation is falling rapidly, and I expect it to continue to fall in the coming months, it would be a surprise if the Federal Reserve doesn't turn to an easing policy soon, possibly at the September meeting. If they don't do so at the September meeting, the market won't treat them kindly."

"A mild inflation report would lead the Federal Reserve to feel completely at ease, and they can turn to labor force totally," said Tom Porcelli, chief U.S. economist of PGIM Fixed Income. "They could have turned their attention to labor far enough few months ago."

Concerns about the Federal Reserve's slow response

The brief increase in initial jobless claims at the beginning of the week, together with other weak economic indicators, briefly led some in the market to seek emergency rate cuts.

Although the sentiment has subsided, people are still worried that the Federal Reserve is moving too slowly to relax its policy, just as it did when inflation began to rise.

Another mild inflation report will "make the Federal Reserve completely at ease, and they can turn their focus from inflation to labor," said Tom Porcelli, chief U.S. economist of PGIM Fixed Income. "They could have turned their attention to labor far enough few months ago."

Cracks appear in the labor market backdrop.

Amid the double reality of falling inflation and rising unemployment rates, the market is pricing in a "definitely rate cut" by the Federal Reserve at the September 17-18 meeting, and the only remaining question is how much it will cut rates by.

According to the calculation of the Chicago Mercantile Exchange, futures prices are roughly divided into a 25 or 50 basis points rate cut in September and is likely to drop by a full percentage point before the end of the year.

However, futures pricing has been far from realistic for most of the time. Traders expected the Federal Reserve to cut interest rates rapidly at the beginning of the year, then converged to only expect one or two rate cuts, and until recently another extreme swing in the opposite direction.

"I'm as curious about Wednesday's CPI report as anyone else, but I don't think the Federal Reserve will change course unless there is a real anomaly," Porcelli said. "that is, refocusing on labor and seriously considering rate cuts in September. They should take proactive action to cut rates. I can easily give the reason why the Federal Reserve should cut rates by 50 basis points, because I think they should have already cut rates. But I don't think they will, they will be humble to start."

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