As investors eagerly await the Federal Reserve’s upcoming decision on interest rates, all eyes are on the latest inflation data set to be released this week.
On Wednesday, the Labor Department’s Bureau of Labor Statistics will unveil the consumer price index (CPI) report for August, followed by the producer price index (PPI) report on Thursday. These reports are crucial in determining the magnitude of the anticipated interest rate cut.
While the Fed is widely expected to lower rates at its next policy meeting on September 18, the key question now is the extent of the rate cut. With conflicting views in the market, the CPI and PPI readings could help provide more clarity.
“Inflation data is becoming increasingly important in shaping Fed policy decisions, especially as the debate over the size of the rate cut intensifies,” noted Citigroup economist Veronica Clark.
Market expectations are for a 0.2% rise in both the CPI and core CPI (excluding food and energy) for August, translating to annual inflation rates of 2.6% and 3.2% respectively. The PPI is also forecasted to increase by 0.2% for both headline and core indices.
While the CPI readings may not align closely with the Fed’s 2% long-run target, there are several factors to consider.
Firstly, the Fed primarily uses the Commerce Department’s personal consumption expenditures price index as its main inflation gauge, which reported headline inflation at 2.5% in July.
Furthermore, policymakers are attentive not just to the inflation levels but also to the directional trends. Recent months have shown a clear moderation in inflation, with a projected 0.3 percentage point decrease in CPI from July to August.
Lastly, the focus of the Fed has shifted from inflation to concerns about the labor market, given the significant slowdown in hiring since April.
A step towards rate cuts
With growing emphasis on labor market conditions, there is mounting anticipation for the Fed to initiate rate cuts. The current benchmark fed funds rate stands at 5.25% to 5.50%.
“The August CPI report is likely to show progress towards bringing the inflation rate closer to the Fed’s target of 2.0 percent,” observed Dean Baker, co-founder of the Center for Economic and Policy Research.
Market sentiment suggests a gradual approach to rate cuts, with futures pricing indicating a 71% likelihood of a quarter-point cut by the Federal Open Market Committee (FOMC) and only a 29% chance of a more aggressive half-point reduction.
However, some economists caution against a conservative approach, pointing to ongoing hiring challenges and potential economic slowdowns in the near future.
While the September rate cut is likely to be modest, market projections signal a more substantial half-point reduction in November and possibly another cut in December.