US CPI preview

US CPI preview: will inflation data move the dial for US rate cuts?

US CPI: will inflation boost hopes for a 50bp Fed rate cut?

By Kathleen Brooks, research director at XTB

US and European stocks lost some steam on Tuesday as economic and political risks stacked up. Ahead of the first election debate between Kamala Harris and Donald Trump, which we will discuss later, stocks in Europe wavered between small gains and losses. There are two questions on investors minds right now: will the US fall into recession, and will the Federal Reserve cut by 25bp or 50bp at their meeting next week?  

Today’s CPI report will be critical at giving us a steer about what size of rate cut is most likely on 18^th September, when the Fed next meets. The non-farm payrolls report was slightly weaker than expected for August, however, it was not weak enough to justify a 50bp cut. This means that investors will look to today’s CPI data to determine if a 50bp cut is necessary next week.

Inflation expected to moderate further

Economists are expecting another moderation in headline CPI, to 2.5% from 2.9% in July, and for core inflation to remain steady at 3.2% YoY. If the estimates for headline inflation are correct, it would mark the fifth consecutive month where headline CPI has moderated. The components of inflation are always worth watching. Core service price growth is still the biggest upward contributor to inflation, so for inflation to fall to a level where the Fed would be worried about deflation, core service prices will need to show signs of collapse in August. There is a chance that core service prices could be weaker than last month’s 2.9% annual rate of growth. The New York Fed reported that consumers are increasingly worried about their ability to keep up with debt repayments and delinquency expectations rose for the third straight month to the highest level since 2020.

Added to this, energy prices have been in freefall over the summer months, and the Brent crude forward curve out to April 2025 is around $70 per barrel, suggesting that the market remains bearish on the outlook for crude oil as we move to the winter months. This is also weighing on inflation expectations, which have fallen at both the long- and short-term horizons. Thus, downside risks for prices in the US are starting to stack up.

Why the Fed won’t cut by 50bp in September

However, if inflation moderates in line with expectations, we do not think that the market will price in a 50bp rate cut, as there will be no reason for the Fed to make such a large move. There is currently a 73% of a 25bp cut from the Fed next week, thus it would take a large downside surprise to shift interest rate expectations for September.

Future rate cut volatility

However, the larger risk from this inflation report is its impact on future interest rate cuts. The market may be expecting a 25bp cut this month, but there is still 208 bps of cuts priced in between November 2024 and September 2025. If inflation moderates as expected, will all of these cuts be justified?

It is also worth noting that there is a 55% chance of a 50bp cut in November, and a 38% chance of another 50bp rate cut in December. If the inflation data is roughly in line with expectations, then questions may be asked about whether cuts of this size can really be justified.

Why 50bp rate cuts are bad for market sentiment

If interest rate expectations are recalibrated, with fewer rate cuts priced in for the coming months, this does not necessarily need to be bad news for markets. Investors loathe large interest rate cuts from central banks as it smells of panic and tends to erode risk sentiment. Recessions are not good for stock markets, so smaller rate cuts and moderate economic growth are much better for the overall market.

How will the financial markets react to US CPI: the case for Apple

There are a couple of trade ideas that are worth considering on the back of the US CPI report on Wednesday. The first is Apple. Its stock price has rallied more than 27% in the last 6 months, at the same time as US inflation has moderated. Apple’s stock price is now the best performer out of the Magnificent 7, and it is outperforming Nvidia, Microsoft and Google along with other big tech names. Apple’s stock price seems to be linked to an orderly decline in price growth and lower interest rates. If we see US headline inflation continue to moderate, then Apple may continue with its rally. Investors may also try to pick up Apple stock after it fell more than 3% over the last 5 days.

If inflation data causes a reduction in expectations for 50bp ‘panic’ rate cuts later this year, then we may also see US stocks rally more broadly. We expect the Dow Jones and the equal- weighted S&P 500 to outperform the tech heavy Nasdaq.

The potential for a dollar recovery

It could also impact the dollar. The USD has lost value in the past month, and it is the weakest performer in the G10 FX space. Against the yen, the dollar is down nearly 4%, against the pound and the euro it is lower by more than 3% each. Thus, a recalibration of interest rate expectations, with fewer rate cuts expected, could give the dollar a chance to recover. USD/JPY is most likely to rally, especially since the market seems less sure about the timing of the BOJ’s next interest rate hike. The dollar could also make some headway vs. the euro and the pound. The extent of the move would depend on a change in rate cut expectations. We think that a 20-30bp reduction in rate cuts for the US in the next year could boost the dollar by 1%.

Overall, the CPI data will not impact the chance of a rate cut from the Fed next week, that is fully baked in. However, it could impact what they say about the prospects for interest rate cuts – their size and magnitude – for the future.