The inflation to be released on Wednesday should provide more clues to the magnitude of the Fed's interest rate cut.

Oscar Munoz, Chief U.S. Macro Strategist at Dowling Securities, says, "I think they will first cut interest rates by 25 basis points next week, but I wouldn't be opposed to a 50 basis point cut."

The Federal Reserve's short-term policy interest rates have remained at their highest level in nearly 20 years, increasing the borrowing costs for families, businesses, and even the U.S. government. People hope that the higher rates can help curb inflation without damaging the economy.

According to the CME Group's FedWatch tool, traders on Tuesday predicted a 70% probability of a 25 basis point rate cut at next week's meeting, while the probability of a 50 basis point rate cut was close to 30%.

CPI becomes the focus.

Tom Essaye, Founder of Sevens Report Research, said in Monday's report, "Wednesday's CPI could be the key factor in determining whether the Fed cuts interest rates by 50 basis points or 25 basis points next week. Overall, the weaker the number, the better for the market, and the greater the possibility of a 50 basis point rate cut by the Fed. Regardless of recent growth data, the market generally welcomes larger expected rate cuts."

According to a survey by The Wall Street Journal, economists expect CPI to rise 0.2% month-on-month in August, bringing the annual inflation rate down from 2.9% in July to 2.6%. The core rate, which excludes volatile food and energy prices, is also expected to rise 0.2% month-on-month, with a year-on-year growth rate of 3.2%.

Chris Diaz, portfolio manager and co-head of global taxable fixed income business at Brown Advisory, said in an interview, 'I don't know why they didn't cut 50 basis points, but it's a big debate in the market.'

Diaz said that Wednesday's August CPI was not as important as the inflation readings in recent months. However, he will still focus on housing costs and the 'super core' portion of the data for clues to the potential direction of Fed interest rate policy.

Munoz of Deutsche Securities said that although inflation has not yet reached the Fed's 2% annual target, the August CPI reading only needs to avoid extreme situations to control market volatility.

Munoz said, 'The risk is that the stock market has rebounded significantly due to expectations of a large interest rate cut by the Fed this year and until 2025.'

Diaz said that due to his concerns about the labor market, he supports a larger rate cut. Despite the monthly increase in employment, previous wage estimates have unexpectedly fallen, and new job openings are concentrated in the government, healthcare, and education sectors - all non-cyclical areas typically weakly correlated with economic conditions.

Diaz said, 'I think there is reason to be concerned about the labor market.'

Stock market and employment.

Since early August, the stock market has been volatile due to the unexpected weak job report in July, raising concerns among investors about a slowing job market. This has also raised questions about whether the Fed is waiting too long to turn to rate cuts.

What is worth noting in Powell's speech at the end of August in Jackson Hole is that he has put inflation concerns in a secondary position, while indicating that the central bank has a limited tolerance for further weakness in the job market.

Marc Chandler, Chief Market Strategist at Bannockburn Global Forex, said, "Powell made it very clear in his speech in Jackson Hole that the focus has shifted and the job market has become more important than inflation."

Chandler said in a phone call that if the August non-farm payroll report released on September 6 does not pave the way for a 50 basis point rate cut by the Fed, "it seems unlikely that CPI data will do so either."

He said that the expected 0.2% month-on-month increase in core CPI in August is not enough to justify a rate cut. However, if there is an unexpected slowdown that leads to a decline of 0.3% to 0.5% in the reading for the month, "it may prompt us to move toward a 50 basis point rate cut," especially if this deceleration is concentrated in the service sector component of CPI.

Looking ahead to September and beyond, federal funds futures on Tuesday hinted that borrowing costs may fall by a full percentage point or more by the end of December, and by 2.5% by the end of 2025.

Diaz of Brown Advisory said that pricing seems to reflect a market that is somewhere between a "soft landing" and a "recession." "We don't think it's excessive in the long run," he said, adding that investors should not rule out the possibility of further rate cuts.

On the other hand, Chandler of Bannockburn believes that the probability of the current rate cut reflects traders' bias towards "pushing things to the extreme." However, he added, "There is concern about a turning point that could lead to a sharp contraction in the job market."

Editor/Rocky