Traders and investors are bracing for one of the year’s pivotal data releases, with July’s Consumer Price Index (CPI) set to hit the markets on Wednesday at 8:30 a.m. ET. This report could be a major determinant of the Federal Reserve’s next move on interest rates, making it crucial for market participants to scrutinize the numbers.
Expectations are that the headline CPI will show a 3.0% year-over-year increase, consistent with June’s reading. On a month-over-month basis, consumer prices are anticipated to rise by 0.2%, a slight acceleration from the previous month’s 0.1% decline, primarily due to an expected uptick in energy costs.
More closely watched by the Fed, the “core” CPI, which excludes the volatile food and energy sectors, is projected to increase by 3.2% year-over-year, a minor slowdown from June’s 3.3% pace. Monthly core inflation is expected to tick up by 0.2%, compared to a 0.1% rise in June, according to Bloomberg data.
Michael Gapen, an economist at Bank of America, highlighted in a note that June’s CPI numbers were unexpectedly low, but he anticipates a reversal of that trend in July. “We expect some of that surprise to reverse in July,” Gapen wrote, indicating that the market should prepare for a potential shift in inflation dynamics.
June’s negative headline CPI was the first since May 2020 and marked the slowest annual price increase since March 2021. Gapen suggests that while July’s numbers may not be as favorable, they should align with the deflationary trend and could meet the Fed’s criteria for beginning rate cuts in September.
Shelter and Service Costs Remain Sticky
The persistence of core inflation is largely attributed to rising shelter costs and core services, including insurance and medical care. After showing signs of deceleration in June, shelter prices are expected to pick up again. The index for rent and owners’ equivalent rent (OER) posted its smallest monthly increases since August 2021, but a reversal is anticipated for July. OER, which estimates the rent a homeowner would pay for their property, remains a significant factor in the inflation equation.
Non-housing services inflation also eased in June, driven by a sharp drop in airfares. However, Bank of America’s Gapen expects the decline in airfares to be much less pronounced in July. He cautions that while services inflation might moderate over time due to cooling wage pressures, a sustained period of deflation is unlikely.
Fed Rate Cuts in Focus
As the market awaits the CPI report, recent data from the Producer Price Index (PPI) has already set the stage for discussions on potential rate cuts. The PPI, a leading indicator of consumer prices, rose just 0.1% month-over-month in July, down from June’s 0.2% increase and below economists’ expectations. On an annual basis, PPI climbed by 2.2%, marginally above the Fed’s 2% target.
John Stoltzfus, chief investment strategist at Oppenheimer, noted the positive implications for equities. “It releases some of the dark sentiment that had gripped [the market] over the course of the start this month. We can’t help but think that this gives the Federal Reserve the opportunity to begin cutting rates,” Stoltzfus commented.
Despite inflation remaining above the Fed’s 2% target, the narrative around the central bank cutting rates has gained traction, especially after July’s jobs report, which triggered a market sell-off. The core Personal Consumption Expenditures (PCE) price index, the Fed’s preferred inflation gauge, remained unchanged in June and recorded the slowest annual increase in over three years.
As of Tuesday, futures markets priced in nearly a 100% probability of a rate cut by the Fed at its September meeting. However, the odds are evenly split between a 25 basis point and a 50 basis point cut, reflecting some uncertainty among traders, as shown by the CME FedWatch Tool.
Key Takeaways
- CPI Release: July’s CPI is expected to show stable headline inflation at 3.0%, with a slight increase in core inflation.
- Fed Rate Cuts: Market pricing suggests a near certainty of a Fed rate cut in September, though the size of the cut remains uncertain.
- Shelter and Services Costs: Core inflation pressures persist, driven by shelter and non-housing services, though there are signs of moderation.
- Market Sentiment: Positive PPI data and a cooling jobs report have fueled expectations for a dovish Fed.
Conclusion
Wednesday’s CPI report will be pivotal in shaping expectations for the Fed’s next policy moves. With inflation dynamics still in flux, traders should prepare for potential volatility as the data is digested. The interplay between shelter costs, service inflation, and broader economic indicators will be critical in determining the trajectory of interest rates and, by extension, market sentiment.
