Inflation Report Expected to Fuel Expectations for Fed Rate Cuts
The much-anticipated Consumer Price Index (CPI) report for June, due out Thursday morning, is expected to provide further evidence of cooling inflation and economic growth, potentially solidifying expectations for the Federal Reserve (Fed) to lower interest rates in the coming months. Recent economic data, including last week’s report showing unemployment rising to 4.1%, has already suggested a softening in both inflation and economic activity.
Key Takeaways:
- Inflation and Economic Growth Cooling: Data suggests both inflation and economic growth are easing, possibly setting the stage for Fed rate cuts.
- CPI Report as a Catalyst: The June CPI report is anticipated to provide further evidence of this cooling trend, potentially pushing the Fed closer to rate reductions.
- Fed Chair Powell’s Testimony: While Federal Reserve Chair Jerome Powell hasn’t explicitly stated a timeline for rate cuts, he has indicated that the Fed is more balanced in its view of the risks to the economy between inflation and recession.
- Market Impact: The stock market and bonds have already rallied in July, fueled by rising confidence in rate cuts. The CPI report could further influence these trends.
- Focus on Trends Over Levels: The Fed may be shifting its focus from inflation and unemployment levels to the trends of these metrics. This shift could favor rate cuts.
A Closer Look at the CPI Report:
Economists surveyed by Dow Jones are forecasting a 0.1% month-over-month increase in CPI and a 3.1% year-over-year rise. The core CPI, which removes volatile food and energy prices, is expected to climb 0.2% from May and 3.4% year-over-year.
While inflation remains elevated compared to the Fed’s 2% target, recent trends are leading experts to believe that the Fed might prioritize the gradual rise in unemployment and the continued downward trajectory of inflation. Matt Brenner, managing vice president of investments and product management at MissionSquare Retirement, believes that this focus on trends, rather than just levels, could increase the likelihood of rate cuts.
Analyzing the CPI Components:
The price changes within the CPI index, particularly in key areas like shelter and medical care services, will be closely examined. Shelter and medical services are particularly significant as they also constitute major components of the Personal Consumption Expenditures (PCE) index, the Fed’s preferred inflation measure.
Tony Roth, Chief Investment Officer at Wilmington Trust, emphasizes the importance of medical services in the PCE index, noting that “We’ve seen medical services [be] pretty tame, and that’s important because medical services makes up a much bigger portion of the PCE, which is the more important of the two inflation prints.”
Market Reactions and Expectations:
The CPI report arrives amidst a positive market environment. Stocks and bonds have rallied in July as traders increase their confidence in rate cuts. The S&P 500 reached a new peak, crossing 5,600 on Wednesday.
Fed funds futures pricing, based on the CME FedWatch Tool, indicates that traders anticipate the Fed to keep rates unchanged at its meeting later this month and potentially cut rates in September. This contrasts with a month ago when the chances of another pause in September were less certain.
While the expected hold in July might limit the market’s immediate reaction to the CPI report, some experts believe that a cooler-than-expected inflation reading could further boost the market. Roth argues that “I don’t think that the market has fully appreciated the weakness in the economy, or the fact that inflation is clearly in the rear view mirror.”
Navigating the Uncertainty:
The upcoming CPI report will undoubtedly hold significant weight in shaping expectations for the Fed’s monetary policy. While the recent trends suggest a shift towards rate cuts, the market remains cautious and is likely to respond with sensitivity to the nuances of the report. The focus on trends over levels in the Fed’s decision-making and the crucial components of the CPI index will play a key role in determining the direction of the market going forward.
