The question of whether the Federal Reserve will raise interest rates in September may be answered tonight.
The US Bureau of Labor Statistics will release the July CPI data at 8:30 AM ET on Wednesday (20:30 Beijing time Wednesday evening). Market consensus expects the overall CPI to rise 0.1% month-over-month and core CPI to rise 0.2% month-over-month, with annual rates falling to 3.4% and 2.5%, respectively.
Following last week's unexpectedly weak non-farm payroll data, this report will serve as a crucial test for the September rate hike expectations. If the data is mild, the market may further lower the probability of a September hike; if the data is hotter than expected, it will put greater pressure on the already hawkish-leaning Fed.
Currently, interest rate futures markets are pricing in the probability of a September rate hike at around 50%, a so-called "coin toss." Last week's non-farm payroll data, showing a decline of 23,000 jobs in July, once significantly cooled rate hike expectations, but a subsequent rebound in oil prices pushed the probability back to an even split. Meanwhile, at the Fed's July policy meeting, three governors voted in favor of a rate hike, and several non-voting members also explicitly expressed a preference for tightening policy, giving hawkish voices considerable weight within the meeting. Tonight's CPI data will directly influence the tilt of this scale.
Mild Reading Highly Likely, But Still Above Target
According to forecasts from Goldman Sachs, Pantheon Macroeconomics, and other institutions, the CPI data is highly likely to fall within the expected range, unlikely to repeat the large fluctuations seen in last month's report.
Goldman Sachs expects July core CPI to rise 0.19% month-over-month, with an annual rate of about 2.47%, both slightly below market consensus; overall CPI is expected to rise only 0.05% month-over-month, with an annual rate of about 3.35%. Falling energy prices (-2.0%) are the main reason for suppressing overall inflation, while food prices are expected to rise modestly by 0.2%.
At the component level, Goldman Sachs expects used car prices to rise 0.5% month-over-month, new car prices to rise 0.1%, but auto insurance prices to fall 0.5%; regarding the housing component, owners' equivalent rent (OER) is expected to rise 0.23% month-over-month, rent to rise 0.16%, continuing the recent slowing trend; travel services are somewhat mixed, with airfare prices expected to rise 2.0% and hotel prices expected to fall 1.0%, partly because the demand boost from the World Cup has gradually faded.
Pantheon Macroeconomics expects core goods prices to rise 0.18% month-over-month, the largest increase since last September, partly influenced by Apple (AAPL) raising prices for most hardware products by 15% to 30% starting June 25th, but weakness in the services component will offset this—the agency expects airfare prices to fall 1.5% month-over-month, lodging prices to fall 1.0%, auto insurance to continue its downward trend, and energy goods prices to fall 2.6%, which will drag down the overall CPI monthly rate by about 11 basis points.
Fed's Stance: On Hold, But Hawkish Noise Growing
RSM Chief Economist Joe Brusuelas stated that if the July CPI is close to expectations, "a majority of the committee will likely choose to ignore supply-side shocks, and the FOMC will keep rates unchanged for the remainder of the year," while providing some buffer for Fed Chair Wash—who has faced policy pressure since taking office in May.
However, hawkish forces within the Fed are gathering. Cleveland Fed President Beth Hammack, one of the three governors who voted for a rate hike at the July meeting, said on Monday that multiple rate hikes may be needed, emphasizing that "a single 25-basis-point adjustment likely has a fairly limited impact on the economy." Additionally, non-voting members Schmid and Musalem indicated they would have been inclined to support a rate hike at the July meeting. While Fed Chair Wash acknowledged that current tightening financial conditions are doing some of the Fed's work and that the July jobs data and its downward revisions have indeed tempered recent tightening expectations, he also did not explicitly rule out the possibility of further hikes.
Bank of America maintains its forecast for three rate hikes in the coming months. The bank's economists noted in a client report that the July employment report "did not change the overall picture of the labor market," and the Fed's policy reaction function remains "highly tilted toward inflation data." The bank warned that if the core CPI monthly rate averages 0.25% over the next two months, "the Fed will almost certainly start hiking in September"; if it averages below 0.2%, the hike will be delayed; if it falls between, then September remains "a coin toss."
Stocks and Bonds Under Pressure, Stock Sentiment Indicator Flashing Red
J.P. Morgan's market intelligence team provided a scenario analysis for the CPI data:
· If core CPI month-over-month exceeds 0.30%, the S&P 500 is expected to fall 1.5% to 2.5%, with a probability of 5%;
· If it falls in the 0.25% to 0.30% range, the index is expected to fall 0.5% to 1.25%, probability 25%;
· If it falls in the 0.20% to 0.25% range (the highest probability scenario, about 40%), the index is expected to rise 0.25% to 0.75%;
· If it is below 0.20%, the gains could expand to 0.5% to 2%. Overall, the bond market's reaction to higher-than-expected inflation will be more severe than the stock market's.
It is worth noting that the current implied volatility magnitude priced by options expiring on August 12 is about 0.9%, slightly below the recent average of about 1.1%, indicating the market does not expect extreme outcomes from tonight's data.
A team led by Wells Fargo analyst Ohsung Kwon warned investors, advising them to set up hedge positions before the CPI release. The bank's sentiment indicator currently reads 1.4, within its strongest "sell" signal range since January 2018. "We believe hedging costs are low and are inclined to hedge the risk of hotter data," the analysts wrote. "If CPI exceeds expectations, the market narrative will quickly shift to stagflation concerns, especially against the backdrop of last week's weak jobs data." However, Wells Fargo also noted that second-quarter corporate earnings grew 30% year-over-year, exceeding market expectations by 8%, the strongest growth in over four years, which still supports the stock market to some extent.
Longer-Term Risks: AI Inflation and Market Structure Signals
Although the short-term inflation outlook is relatively mild, Societe Generale analyst Andrew Lapthorne pointed out that the structure of the stock market is sending warning signals. The bank's equity inflation proxy index, constructed from developed market stocks most correlated with inflation, has significantly outperformed the MSCI World Index over the past 12 months, accumulating a 71% gain. Lapthorne stated:
"The market is no longer expecting the contradictory combination of 'strong earnings growth + rate cuts,' but rather believes that such strong earnings growth typically accompanies the need for rate hikes."
Meanwhile, commodities related to the AI industry chain are facing upward pressure. Reportedly, soaring memory prices could push up core PCE by 0.5 percentage points. Goldman Sachs expects the July core PCE month-over-month rate to record a larger 0.26% increase, partly reflecting the lagged transmission of second-quarter stock price gains to investment portfolio management service costs. A methodological adjustment for this item's classification will be implemented at the end of September, at which point related data may be revised downward, but a subsequent revision in December could reintroduce strong correlations.
More Data Ahead, September Decision Still Hanging in the Balance
Even if tonight's CPI outcome becomes clear, the direction of a September rate hike is still not settled. Before the September 16 FOMC meeting, the Fed will also receive August non-farm payrolls, August CPI, and August PPI data, while August PCE will only be released after the meeting concludes. This means there is ample room for policy expectations to shift in the coming weeks.
Overall, the highest probability scenario is data in line with expectations, which is neither sufficient to reignite the flames of a September hike nor enough for the market to completely dismiss tightening expectations. The final verdict in the hawk-dove debate remains in the hands of subsequent data and Chair Wash.
