Although CPI data was lower than expected, the market seemed somewhat disappointed with this data. Did the expectation of a 50 basis point rate cut in September fall through?
US inflation slowed for the fourth consecutive month in July, making it likely for the Federal Reserve to lower interest rates next month.
CPI data released on Wednesday showed that the US July non-seasonally adjusted CPI was 2.9% YoY, falling for the fourth consecutive month and returning to the "2-digit" range for the first time since March 2021, lower than the market expectation of 3%, with a monthly rate of 0.2%, consistent with market expectations. The non-seasonally adjusted core CPI, which excludes food and energy prices, was 3.2% YoY in July, falling for the fourth consecutive month to its lowest level since April 2021, with a monthly rate of 0.2%, also in line with market expectations.
Although the data released by the US Bureau of Labor Statistics has only one decimal point, Federal Reserve officials and economists like to observe it further to gain a better understanding of the inflation trajectory. When calculated by two digits, the core CPI increased by 0.17% MoM. To understand recent trends, the annual rate of increase for the three months rose to 1.58%, the lowest level since February 2021.
The largest category in the service industry, housing prices, rose by 0.4%, the lowest level since 2021, compared to 0.2% in June. Equivalent rent of owner-occupied housing, also a subset of housing and the largest personal composition part of the CPI, also rose by 0.4%. The main residential rent rose 0.5%, the highest increase since February, which may raise questions after the volatility earlier this year.
Bank of Montreal Capital Markets pointed out that while the stickiness of housing costs is a noteworthy aspect of this report, "this is a very as-expected update and we maintain our base assumption of a 25-basis-point rate cut by the Federal Reserve in September."
After the release of this data, interest rate traders reduced their bets on a 50-basis-point rate cut at the Federal Reserve's September meeting, expecting a cut of about 33 basis points, compared to yesterday's forecast of 37 basis points.
Adam Button, an analyst at finance website Forexlive, said the market's pricing of a Fed rate cut within the year fell from 106 basis points before the data release to 103 basis points. This is a slightly hawkish reaction, indicating that the market has initially priced in more downside surprises. "Nevertheless, the unrounded inflation figures are better than the overall numbers."
Lindsay Rosner, a multi-sector fixed-income manager at Goldman Sachs Asset Management, still believes that the CPI data tonight has paved the way for a 25-basis-point rate cut by the Federal Reserve in September, but considering that there will be more data in the future, the possibility of a 50-basis-point rate cut has not been ruled out.
As the economy slows down slowly and the overall trend of inflation remains downward, coupled with a weak job market, it is generally expected that the Federal Reserve will start cutting interest rates next month, and the size of the rate cut may depend on more data that will be released soon.
Before the September meeting, officials will have access to more inflation data and another non-farm employment report. After the disappointing July non-farm data triggered a global sell-off and exacerbated concerns about an economic downturn, the report will be closely scrutinized. For Federal Reserve Chairman Powell and his colleagues, a substantive further weakening of the labor market will be more important than the "okay, but not great" CPI data.
Powell and his colleagues have recently stated that they will pay more attention to their dual mandate of full employment, and they may emphasize this at the annual symposium in Jackson Hole, Wyoming, next week.
Editor/Lambor