Tonight's US CPI Expected to Moderate, September Rate Hike Expectations May Face Another Blow

Original author: Zhang Yaqi

Source: Wall Street CN

Whether the Federal Reserve will raise interest rates in September — the answer may be revealed tonight.

The U.S. Bureau of Labor Statistics will release July CPI data at 8:30 a.m. ET on Wednesday (8:30 p.m. Beijing time). Market consensus expects headline CPI to rise 0.1% month-over-month and core CPI to rise 0.2%, with annual rates easing to 3.4% and 2.5%, respectively.

Following last week's unexpectedly soft nonfarm payrolls report, this release will serve as a key litmus test for September rate hike expectations. If the data comes in moderate, the market may further lower the odds of a September hike; if it runs hotter than expected, it will put greater pressure on an already hawkish Fed.

Currently, interest rate futures markets price roughly a 50% probability of a September hike — a true coin flip. Last week's payrolls data showed a decline of 23,000 jobs in July, which briefly cooled rate hike expectations, but a subsequent rebound in oil prices pushed the odds back to even. Meanwhile, three governors voted for a rate hike at the July FOMC meeting, and several non-voting members also explicitly leaned toward tightening, giving the hawkish camp considerable weight within the committee. Tonight's CPI data will directly determine which way the scales tip.

Moderate Reading Likely, But Still Above Target

Based on forecasts from Goldman Sachs, Pantheon Macroeconomics, and other institutions, this CPI report will most likely land within the expected range and is unlikely to reproduce the sharp swings seen in last month's release.

Goldman Sachs expects July core CPI to rise 0.19% month-over-month, with an annual rate of approximately 2.47% — both slightly below market consensus. Headline CPI is expected to rise just 0.05% month-over-month, with an annual rate of approximately 3.35%. Falling energy prices (-2.0%) are the main drag on headline inflation, while food prices are expected to rise a moderate 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%. On the housing front, owners' equivalent rent (OER) is expected to rise 0.23% month-over-month and rents to rise 0.16%, continuing the recent slowdown trend. Travel services components are mixed, with airfares expected to rise 2.0% and hotel prices to fall 1.0%, partly reflecting the fading demand boost from the World Cup.

Pantheon Macroeconomics expects core goods prices to rise 0.18% month-over-month — the largest increase since last September — partly due to Apple's (AAPL) 15% to 30% price increases on most hardware products effective June 25. However, weakness in services components will offset this, with the firm expecting airfares to fall 1.5% month-over-month, accommodation prices to drop 1.0%, auto insurance to continue its downtrend, and energy goods prices to decline 2.6%, dragging headline CPI by roughly 11 basis points.

Fed Stance: Holding Steady, But Hawkish Noise Intensifying

Joe Brusuelas, chief economist at RSM, said that if July CPI comes in near expectations, "a majority of committee members will choose to look through the supply-side shock, and the FOMC will hold rates steady for the remainder of the year," while providing some breathing room for Fed Chair Warsh — who has faced sustained policy pressure since taking office in May.

However, hawkish forces within the Fed are building. Cleveland Fed President Beth Hammack, one of three governors who voted for a rate hike at the July meeting, said Monday that multiple rate hikes may be needed, stressing that "the economic impact of a single 25-basis-point adjustment is likely quite limited." Additionally, non-voting members Schmid and Musalem indicated they would have favored a rate hike at the July meeting. While Fed Chair Warsh acknowledged that tightening financial conditions are doing some of the Fed's work and that July's jobs data and its downward revisions have tempered near-term tightening expectations, he has not explicitly ruled out further rate hikes either.

Bank of America, meanwhile, maintains its forecast of three rate hikes over the coming months. The bank's economists noted in a client report that the July jobs report "does not change the overall picture of the labor market," and the Fed's policy reaction function remains "highly skewed toward inflation data." The bank warns that if core CPI averages 0.25% month-over-month over the next two months, "the Fed will almost certainly begin hiking in September"; if the average falls below 0.2%, hikes will be delayed; and if it lands in between, September remains "a coin flip."

Stocks and Bonds Both Under Pressure; Equity Sentiment Flagging Red

JPMorgan's market intelligence team provided a scenario analysis for tonight's CPI release:

• If core CPI exceeds 0.30% month-over-month, the S&P 500 is expected to fall 1.5% to 2.5%, with a 5% probability;
• If it falls in the 0.25% to 0.30% range, the index is expected to decline 0.5% to 1.25%, with a 25% probability;
• If it lands in the 0.20% to 0.25% range (the highest-probability scenario at approximately 40%), the index is expected to rise 0.25% to 0.75%;
• If it comes in below 0.20%, gains could expand to 0.5% to 2%. Overall, the bond market is expected to react more violently than equities to an inflation overshoot.

Notably, options priced through the August 12 expiration imply an intraday move of approximately 0.9%, slightly below the recent average of around 1.1%, suggesting the market does not anticipate an extreme outcome from tonight's data.

Wells Fargo analysts led by Ohsung Kwon, meanwhile, are warning investors to position hedges ahead of the CPI release. The bank's sentiment indicator currently reads 1.4, in its strongest "sell" signal territory since January 2018. "We see hedging costs as low and would prefer to hedge against hot data risk," the analysts wrote. "If CPI surprises to the upside, the market narrative will quickly shift toward 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, beating expectations by 8% — the strongest growth in over four years — which provides some support for equities.

Longer-Term Risks: AI Inflation and Market Structure Signals

Despite a relatively benign near-term inflation outlook, Societe Generale analyst Andrew Lapthorne points out that equity market structure is flashing warning signs. The bank's equity market inflation proxy, built on developed-market stocks most correlated with inflation, has significantly outperformed the MSCI World Index over the past 12 months, rising 71% cumulatively. Lapthorne noted:

"The market is no longer pricing in the contradictory combination of 'strong earnings growth + rate cuts,' but rather acknowledges that such robust earnings growth typically comes with the need for rate hikes."

Meanwhile, commodities tied to the AI supply chain are facing upward price pressure. Reports suggest surging memory prices could push core PCE up by as much as 0.5 percentage points. Goldman Sachs expects July core PCE to post a relatively large 0.26% month-over-month increase, partly reflecting the lagged pass-through of second-quarter stock price gains into portfolio management services costs. A methodological adjustment to this component is scheduled for implementation at the end of September, which could result in downward revisions, but a December revision may reintroduce strong correlations.

More Data Ahead; September Decision Still Up in the Air

Even if tonight's CPI outcome is clear, the path to a September rate hike remains undetermined. Before the September 16 FOMC meeting, the Fed will receive the August nonfarm payrolls report, August CPI, and August PPI data, while August PCE will not be released until after the meeting. This means policy expectations still have ample room to shift in the coming weeks.

On balance, the highest-probability scenario is that the data comes in line with expectations — not enough to rekindle September hike flames, nor sufficient to fully extinguish tightening expectations. The ultimate verdict in the hawk-dove debate still rests with incoming data and Chair Warsh.