Eliza Wong
Wall Street traders are bracing for tonight’s August Consumer Price Index (CPI) release, which is expected to show persistent inflationary pressures. Yet, despite these concerns, market participants overwhelmingly believe the Federal Reserve will proceed with a September rate cut following unexpectedly weak employment data. The real significance of tonight’s inflation report lies not in whether the Fed will cut rates this month, but in how it might shape the central bank’s policy trajectory through the remainder of 2024 and into 2025.
The September Rate Cut: Why It’s Already Priced In
The market has effectively locked in expectations for a September rate cut following the disappointing August jobs report. With employment growth slowing significantly and unemployment concerns mounting, the Fed appears poised to provide monetary stimulus regardless of tonight’s CPI reading.
Employment Data Trumps Inflation Concerns
The unexpectedly weak non-farm payrolls report has shifted market priorities dramatically. While inflation remains above the Fed’s 2% target, the threat to economic growth from deteriorating labor market conditions has taken precedence in the near-term policy calculus.
Market Pricing Reflects Certainty
Futures markets currently price in a 94% probability of a 25-basis-point cut at the September 17-18 meeting. This overwhelming consensus demonstrates how thoroughly the September rate cut has been baked into market expectations.
Tonight’s CPI: Measuring Its True Impact
While unlikely to derail the September rate cut, tonight’s inflation data will significantly influence how traders anticipate subsequent Fed moves. The report serves as a crucial piece in the puzzle for forecasting the pace and extent of the easing cycle.
Options Market Expectations
According to Stuart Kaiser, Citigroup’s U.S. equity trading strategy head, options traders are pricing in only a 0.7% move for the S&P 500 following the CPI release. This muted expectation suggests:
– Lower volatility pricing compared to the 0.9% average move on CPI days over the past year
– Less concern about inflation data than previously seen
– Greater focus on employment indicators for near-term policy direction
The Limited Scope for Surprise
Given market expectations for continued elevated inflation, the CPI report would need to dramatically exceed forecasts to alter the September rate cut trajectory. Most analysts consider this scenario unlikely based on current economic indicators.
The Real Battle: October and Beyond
While September’s rate cut appears certain, the path for subsequent meetings remains highly dependent on incoming data. Tonight’s CPI report will play a crucial role in shaping expectations for the October and December meetings.
Morgan Stanley’s Assessment
Andrew Tyler, J.P. Morgan’s head of global market intelligence, notes that while current data doesn’t threaten the September move, significantly hawkish inflation numbers could alter the projected path for additional cuts. His team outlines several scenarios:
– Core CPI between 0.3%-0.35%: S&P 500 moves -0.25% to +0.5%
– Core CPI between 0.25%-0.3%: S&P 500 gains 1%-1.5%
– Core CPI below 0.25%: S&P 500 surges 1.25%-1.75%
– Core CPI above 0.4%: S&P 500 drops 2% (5% probability)
Bank Forecast Revisions
Several major banks have recently updated their rate projections, anticipating more aggressive easing than previously expected. Barclays economists now forecast three 25-basis-point cuts in 2024, followed by two additional cuts in 2025.
Economic Context: Growth Versus Inflation
The current economic landscape presents a complex picture for policymakers. While inflation remains stubbornly above target, growth indicators continue to show resilience, creating tension between the Fed’s dual mandate objectives.
Strong Growth Metrics
The Atlanta Fed’s GDPNow model projects third-quarter growth at a 3% annualized rate, only slightly below the second quarter’s 3.3% pace. This economic strength helps explain why the VIX volatility index remains below the 20 level that typically signals investor concern.
The Surprise Index Dynamic
Citigroup’s Economic Surprise Index, which measures whether data exceeds or misses expectations, has approached its highest level since January. While typically positive for risk assets, strong economic data now creates complications by potentially forcing the Fed to maintain higher rates for longer.
The Labor Market’s Central Role
Ultimately, the employment situation remains the critical factor in Fed policy decisions. The September rate cut reflects growing concerns about labor market softening, and future moves will depend heavily on whether this trend continues.
Citigroup’s Perspective
As Stuart Kaiser emphasizes, “Everything ultimately depends on the labor market. If the Fed cuts again in October, it would likely mean employment data continues to soften without unexpected inflation upside.”
The Delicate Balance
The Fed must navigate between supporting employment growth and controlling inflation—a challenge complicated by signs of economic softening in certain sectors while overall growth remains robust.
Looking Beyond September
While the September rate cut appears certain, the broader policy trajectory remains highly data-dependent. Market participants should focus on several key factors beyond tonight’s CPI report:
– Subsequent employment reports
– Retail sales and consumption data
– Business investment indicators
– Global economic developments
– Financial conditions and credit availability
Strategic Implications for Investors
Given the expected September rate cut and uncertain subsequent path, investors should consider several strategic approaches:
– Duration positioning in fixed income portfolios
– Sector rotation opportunities in equities
– Currency implications of divergent monetary policies
– Volatility trading strategies around data releases
As the Fed embarks on its easing cycle, tonight’s CPI data provides important clues about how aggressive this cycle might become. While September’s move appears locked in, the subsequent path remains highly dependent on incoming economic data, particularly regarding inflation persistence and labor market conditions.
Monitor upcoming economic releases closely, particularly employment data and additional inflation indicators, to gauge whether the Fed’s easing cycle will proceed as currently anticipated or face obstacles from persistent price pressures. The balance between growth concerns and inflation risks will determine the pace and extent of monetary policy normalization through 2025.
