Source: Wall Street See
Author: Zhao Ying

How many basis points will the Federal Reserve cut interest rates in September? With the non-farm payroll data failing to provide a definitive answer, the focus of the market has shifted to tonight's CPI data. Will the two camps of a 25 and 50 basis point rate cut see a "decisive battle"?

At 20:30 on Wednesday Beijing time, the U.S. Bureau of Labor Statistics will release the August CPI data. Currently, Wall Street generally expects:

In August, both the U.S. CPI and core CPI increased by 0.2% month-on-month, unchanged from the previous month.

In terms of year-on-year growth, the market expects that CPI in August will increase by 2.5%, down from the previous value of 2.9%, and core CPI will stay unchanged at 3.2%, only one-third of what it was two years ago.

Regarding the impact of the August CPI on the Federal Reserve's decision, Wells Fargo & Co. stated that the FOMC will hold an interest rate meeting on September 18th, and a rate cut is almost a "done deal", while the August non-farm payroll report is in a clearly weak and strong "gray area". The upcoming CPI data could become the decisive factor in determining whether the rate cut will be 25 basis points or 50 basis points.

According to the FedWatch Tool of the Chicago Board of Trade (CBOT), the probability of a 25 basis point rate cut by the Federal Reserve in September is 67%, while the probability of a 50 basis point rate cut is 33%. Analysts believe that in line with expectations, CPI will reinforce the expectation of a 25 basis point cut, while unexpectedly cooling inflation will increase the possibility of a 50 basis point cut. The weaker CPI data in August, the more favorable for the market, the greater the likelihood of a 50 basis point rate cut.

Rents are expected to return to a downward trend, while airfare and used car prices may rebound.

Looking at the sub-item data, analysts believe that after the abnormal rise in the western region in July, rent inflation in August is expected to be lower than in July, and the main reasons for the recent softening inflation are expected to be the rebound in airfare and used car prices, while automobile insurance inflation is expected to slow down, with clothing prices being the biggest variable.

First, let's look at rents. Aichi Amemiya, an economist at Nomura, says that the All Tenants Returning Rent Index (ATRR) of the U.S. Bureau of Labor Statistics is the most reliable leading indicator, indicating that official rent inflation is declining. In addition, the supply of rental apartment buildings remains high, so the potential trend of rent inflation is unlikely to accelerate again in the near future. If rent inflation declines, this will help offset the rebound in other service categories (such as medical care and airfare) after the abnormal decline in July.

Goldman Sachs believes that after a significant increase in July, housing inflation is expected to moderate, with owner-equivalent rent (OER) rising by 0.33% and primary rent rising by 0.29%. However, looking ahead, rental growth in single-family houses will slightly accelerate, which may cause OER to exceed rent in the CPI. It is expected that the overall housing inflation rate will run at a monthly rate of around 0.3% by December 2024.

It is worth noting that Goldman Sachs points out that the core CPI forecast for August is higher than the average growth rate of 0.13% in the past three months. The recent softening of data is mainly driven by a decline in airfare prices (averaging 3.4%) and used car prices (averaging 1.1%), but due to seasonal factors such as the summer travel season, airfare prices are expected to rebound in August (+1.5%); the decline in used car prices is also more moderate (-0.5%), reflecting mixed auction prices.

Secondly, automobile insurance inflation is expected to slow down. For the past two years, automobile insurance inflation has been a major driver of U.S. service industry inflation, but there are signs that insurers may slow down the pace of price increases in the coming months. Morgan Stanley analysis suggests that insurance rate applications in July appear to have begun to decelerate, and this trend is expected to continue, with automobile insurance CPI showing more obvious deceleration before the end of the year.

In addition, clothing prices may be an important variable in shaping the CPI for August. In July, clothing prices saw the largest decline this year, and analysts have different opinions on whether prices will drop again in August, which means that any significant fluctuations could affect the overall inflation reading.

The "decisive battle" for the Fed's 25 or 50 basis point cut in September.

Non-farm data did not "set the tone" for a September rate cut, and US CPI may set the tone.

Analysts generally believe that the expected CPI will consolidate the expectation of a 25 basis point cut. Oscar Munoz, Chief Strategist at DZ Bank, believes that a 25 basis point rate cut will start next week. The Federal Reserve's short-term policy interest rates are nearing their highest level in 20 years, raising borrowing costs for households, businesses, and even the US government. People have always hoped that raising interest rates would help curb inflation without derailing the economy.

Regarding the possibility of a 50 basis point rate cut, Marc Chandler, strategist at Bannockburn Global Forex, said:

The non-farm report did not pave the way for a 50 basis point rate cut by the Federal Reserve, so it seems unlikely that CPI will do so as well. The current expectations are not enough to support a 50 basis point rate cut. However, if there is an unexpected slowdown and core CPI is -0.3% to -0.5%, it could push us to the edge of a 50 basis point cut, especially if inflation deceleration is concentrated in the CPI services sector.

However, economists Veronica Clark and Andrew Hollenhorst at Citigroup stated in a data preview on September 9th:

In terms of correlation with Federal Reserve policy decisions, inflation data is quickly giving way to labor market data, but since there is no conclusion on the August employment report, the August CPI data may have an impact.

Given the increasing downside risks to the labor market and economic activity, weak CPI data and the prospect of a larger threshold for rate cuts may be low.

How will the market react?

So, how much of a splash will tonight's CPI announcement make in the market?

According to Goldman Sachs, weak data close to expectations may be the best outcome, allowing for some risk transfer and a slight decrease in stock volatility in the short term. Data that is either too hot or too cold may bring more uncertainty to the Fed's interest rate path and the level of economic growth in the United States.

According to Goldman Sachs traders' predictions, if the core CPI rises by 0.2%-0.25% month-on-month, which is in line with or slightly higher than market expectations,$S&P 500 Index (.SPX.US)$or fluctuates up and down by 0.5%, but if it falls slightly below market expectations, the S&P 500 index is expected to achieve stronger gains.

Editor/rice