Despite the overall inflation in the United States moving solidly towards the Federal Reserve's target, the stickiness of core inflation exceeds market expectations, significantly cooling expectations for a 50 basis point rate cut by the Federal Reserve next week.

The US Bureau of Labor Statistics released data on Wednesday:

In August, the US CPI rose 2.5% year-on-year, in line with expectations, a significant decrease from the previous value of 2.9%. It has slowed down for the fifth consecutive month, reaching the lowest level since February 2021. It rose 0.2% month-on-month, in line with expectations and the previous value.

In August, the core CPI in the United States (excluding volatile food and energy costs) rose by 3.2% year-on-year, in line with expectations and the previous value. It had been decelerating for the past four months, with a month-on-month increase of 0.3%, slightly higher than the expected and previous value of 0.2%, marking the largest increase in four months.

After the data was released, traders lowered their bets on a significant rate cut by the Federal Reserve in September. The US dollar index and US bond yields rose in the short term, while US stock futures declined in the short term.

Housing and transportation costs support inflation, while energy and used car prices continue to decline.

The overall inflation slowed down in August mainly due to a decline in commodity prices:

Commodity prices fell by 1.9% year-on-year, reaching the lowest level since 2004; service prices continued to rise year-on-year, but at the slowest pace since 2022.

The core inflation rate unexpectedly increased, mainly due to the accelerated growth of housing and transportation costs. Specifically:

Housing costs rose by 0.5% on a month-on-month basis, with the owner's equivalent rent index (OER) rising by 0.5%, the largest increase since January and the second consecutive month of increases, breaking the general expectations of decline. The rent index rose by 0.4%, lodging away from home index rose by 1.8%, and in July it rose by 0.2%.

After five consecutive months of decline, airfare prices rose by 3.9% in August, yet airfares are still cheaper than the same period last year.

After a 2.3% drop in July, used car and truck prices fell by 1.0% in August; new car prices remained largely stable.

Medical care costs fell by 0.1% in August, compared to a 0.2% decrease in July.

Furniture prices decreased by 0.3%, reversing the 0.3% increase from the previous month.

Following stability in July, energy prices declined by 0.8% in August, with gasoline prices falling by 0.6% month-on-month, electricity prices decreasing by 0.7%, and natural gas prices dropping by 1.9%.

In terms of autos, the price of used cars fell by 1.0%, easing compared to the 2.3% decline last month; while aviation ticket prices rose by 3.9%, up from a 1.2% decline the previous month. Auto insurance costs rose 1.2% in July and then another 0.6%.

It is worth noting that although the Fed is about to start cutting interest rates, inflation refuses to be "killed", with the so-called super core CPI rising by 0.33% month-on-month, the largest monthly increase since April, driven by continued acceleration in transportation services, the largest increase in 5 months.

Will there be a 25 basis point rate cut in September?

Due to an unexpected rise in core month-on-month inflation, the current CME tool shows that traders expect the probability of a 50 basis point rate cut in September to be less than 20%, while the probability of a 25 basis point rate cut has risen to 83%.

Analysts tend to be cautiously optimistic about this inflation report, with some previously expecting inflation to continue to exceed expectations.

Josh Jamner, an investment strategy analyst at ClearBridge Investments, said that today's release "will disappoint the short-term bond market, as these markets have already anticipated a 250 basis point rate cut by the end of 2025."

Today's data is slightly unfavorable, but it will not prevent the Fed from starting to normalize monetary policy next week, although it may redefine future rate paths.

There are further signs that inflation may be more challenging than previously expected, which could result in a slower and smaller rate-cutting cycle.

Brian Coulton, Chief Economist at Fitch Ratings, bluntly pointed out:

This reminds us to not get too excited about the improvement in inflation data over the past few months.

Chris Zaccarelli, Chief Investment Officer at Independent Advisor Alliance, wrote in a report that the Fed has now given the "green light" for a 25 basis point rate cut next week.

Some may be disappointed that the inflation data did not fall below expectations, which could provide more room for the Fed to cut rates by 50 basis points. However, most Fed officials have expressed their desire for a slow, rather than aggressive, rate cut.

Chris Larkin, a trader at Morgan Stanley, said that the market widely expects the Fed to cut rates by 25 basis points next week, and today's CPI data more or less aligns with the expectation of a 25 basis point rate cut. Investors who were hoping for a larger rate cut may be disappointed, but as inflation seems to be under control, the market may shift its focus back to economic growth, particularly the employment situation.

Chris Low, an analyst at FHN Financial, believes that describing the CPI report to be released tonight as a "poor report" would be a mistake.

Some departments have risen significantly, but the most headache-inducing OER and air ticket prices have risen after months of good news. At the same time, inflation is slowing down, and the year-on-year decline in CPI inflation rate is a clear proof.

David Kelly, an analyst at JPMorgan Asset Management, told Bloomberg that the August CPI data is more of a distraction for next week's interest rate decision, as the core data is slightly higher than expected this month. But he added that inflation has cooled to 'room temperature', indicating that there is no 'significant' inflation problem.

Overall, I think it is well controlled. It seems that we have not seen the risk of deflation.

Editor/ping