Will Tonight's U.S. CPI Data Crush Expectations for a September Rate Hike?

Original Title: "Will Tonight's U.S. CPI Report Crush September Rate Hike Expectations?"
Original Author: Zhang Yaqi, Wall Street News

Whether the Fed will raise rates in September may be revealed tonight.

The U.S. Bureau of Labor Statistics will release the July CPI data at 8:30 am ET on Wednesday (8:30 pm Beijing time on Wednesday). The market generally expects a 0.1% month-over-month increase in the overall CPI and a 0.2% month-over-month increase in the core CPI, with year-over-year rates falling to 3.4% and 2.5%, respectively.

Following the unexpected softness in last week's nonfarm payrolls data, this report will be a key litmus test for the September rate hike expectations. If the data is moderate, the market may further reduce the probability of a September rate hike; if the data is hotter than expected, it will put additional pressure on the already hawkish Fed.

Currently, the fed funds futures market prices the probability of a September rate hike at around 50%, the so-called "coin toss." Last week's nonfarm payrolls data showed a decrease of 23,000 in July employment, leading to a significant cooling of rate hike expectations, but a subsequent rebound in oil prices pushed the probability back to equilibrium. At the same time, at the Fed's July policy meeting, three board members voted in favor of a rate hike, and several non-voting members also clearly stated their policy tightening stance, giving hawkish voices a significant weight within the meeting. Tonight's CPI data will directly influence this delicate balance.

A Moderate Reading Likely, but Still Above Target

Based on forecasts from institutions such as Goldman Sachs and Pantheon Macroeconomics, this CPI data is likely to fall within the expected range, unlikely to reproduce the significant fluctuations seen in last month's report.

Goldman Sachs expects the core CPI to rise by 0.19% month-over-month in July, with a year-over-year rate of around 2.47%, slightly below market consensus; the overall CPI is expected to rise by only 0.05% month-over-month, with a year-over-year rate of around 3.35%. The primary factor suppressing overall inflation is the decline in energy prices (-2.0%), while food prices are expected to rise modestly by 0.2%.

At a disaggregated level, Goldman Sachs expects used car prices to rise by 0.5% month-over-month, new car prices to rise by 0.1%, but auto insurance prices to fall by 0.5%; in the housing component, owner's equivalent rent (OER) is expected to rise by 0.23% month-over-month, rent to rise by 0.16%, continuing a recent moderation trend; travel services will see some differentiation, with airfare prices expected to rise by 2.0% and hotel prices expected to fall by 1.0%, partly due to the gradual fading of the demand boost from the World Cup.

Pantheon Macroeconomics expects a 0.18% month-over-month increase in core commodity prices, the largest surge since September last year, partly driven by Apple's (AAPL) decision to raise prices on most hardware products by 15% to 30% starting June 25, but the weakness in the services component is expected to offset this — the institution projects a 1.5% decrease in airfare prices, a 1.0% decrease in accommodation prices, a continued decline in car insurance, and a 2.6% drop in energy commodity prices, which will drag the overall CPI rate down by around 11 basis points.

Fed Stance: Holding Steady, but Hawkish Noise Grows Louder

RSM Chief Economist Joe Brusuelas suggests that if July's CPI aligns with expectations, "a majority of the Committee will choose to look through supply-side shocks, and the FOMC will keep rates steady for the remainder of the year," providing some cushion for Fed Chair Powell — who has faced ongoing policy pressure since taking office in May.

However, hawkish forces within the Fed are gathering strength. Cleveland Fed President Beth Hammack, one of three directors who voted for a rate hike in the July meeting, stated on Monday that multiple rate increases may be necessary, emphasizing that "a one-time 25-basis-point adjustment would likely have a relatively limited impact on the economy." In addition, non-voting members Schmid and Musalem also indicated that they would have leaned towards supporting a rate hike in the July meeting. While Fed Chair Powell acknowledges that the current tightening of financial conditions is substituting for some of the Fed's work and the July jobs data, along with its downward revision, has indeed dampened near-term tightening expectations, he has not explicitly ruled out the possibility of further rate hikes.

Bank of America, on the other hand, maintains its forecast for three rate hikes in the coming months. The bank's economists noted in a client report that the July jobs report "did not alter the overall picture of the labor market," and the Fed's policy reaction function remains "highly tilted towards inflation data." The bank warned that if the average core CPI rate over the next two months reaches 0.25%, "the Fed almost certainly will start raising rates in September"; if it averages below 0.2%, the rate hike will be delayed; if it falls between the two, then September is "still on the fence."

Stocks and Bonds Under Pressure, Stock Market Sentiment Indicator Flashing Red

JPMorgan's Market Intelligence team provided a scenario analysis for this CPI data:

· If the core CPI rate exceeds 0.30%, the S&P 500 Index is expected to fall by 1.5% to 2.5%, with a 5% probability;

· If the inflation rate falls within the 0.25% to 0.30% range, the index is expected to decline by 0.5% to 1.25%, with a 25% probability;

· If the inflation rate falls within the 0.20% to 0.25% range (the most probable scenario at around 40%), the index is expected to rise by 0.25% to 0.75%;

· If the inflation rate is below 0.20%, the increase is likely to expand to 0.5% to 2%. Overall, the bond market's reaction to higher-than-expected inflation is expected to be more intense than that of the stock market.

It is worth noting that the implied volatility on options priced on August 12th is approximately 0.9%, slightly lower than the recent average level of around 1.1%, indicating that the market does not expect extreme results from tonight's data.

A team led by Wells Fargo Bank analyst Ohsung Kwon has issued a warning to investors, recommending hedging positions ahead of the CPI release. The bank's sentiment indicator currently reads 1.4, signaling the strongest "sell" signal range since January 2018. "We believe hedging costs are relatively low and tend to hedge the risk of overheated data," the analyst wrote. "If the CPI comes in higher than expected, the market narrative will quickly shift to stagflation concerns, especially against the backdrop of last week's weak employment data." However, Wells Fargo Bank also pointed out that second-quarter corporate profits have grown by 30% year-on-year, exceeding market expectations by 8%, marking the strongest growth rate in over four years, which still provides support for the stock market to some extent.

Longer-term Risk: AI Inflation and Market Structure Signals

Despite the relatively mild short-term inflation outlook, Societe Generale analyst Andrew Lapthorne pointed out that the market structure is sending warning signals. The bank has constructed a market inflation proxy index based on developed market stocks most related to inflation, which has outperformed the MSCI World Index by 71% in the past 12 months. Lapthorne stated:

"The market no longer expects the contradictory combination of 'strong earnings growth + rate cuts,' but instead believes that such strong earnings growth usually comes with rate hike demands."

Meanwhile, commodities related to the AI industry are facing upward pressure. It is reported that the surge in memory prices could push the core PCE up by 0.5 percentage points. Goldman Sachs expects a significant 0.26% increase in the July core PCE month-over-month, partly reflecting the lagged impact of second-quarter stock price gains on portfolio management service costs. The methodological adjustment of this project classification is scheduled to be implemented at the end of September, at which point the related data may be revised downward, but a revision in December could reintroduce a strong correlation.

Subsequent Data Abundant, September Decision Still Pending

Even if the CPI results are clear tonight, the direction of a rate hike in September is still undecided. Prior to the FOMC meeting on September 16, the Fed will also receive the August nonfarm payroll, August CPI, and August PPI data, while the August PCE data will only be released after the meeting. This means that there is still ample room for policy expectations to change in the coming weeks.

Overall, the most likely scenario is that the data meets expectations, which is neither enough to reignite the flames of a September rate hike nor sufficient to completely dispel tightening expectations in the market. The ultimate decision between the hawks and doves still rests in the hands of subsequent data and Powell.

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