Will tonight's CPI stimulate the Fed to cut interest rates by 50 basis points in September?

Investors betting on further gains in the US Treasury market are paying close attention to the upcoming US inflation data, hoping that this data will further confirm the reasons for the Fed to accelerate its rate cut pace.

Traders are divided on whether the Fed will cut rates by 25 basis points or 50 basis points in September, with futures trading indicating that the market expects a 36 basis point rate cut in September. Overall, they expect the Fed to cut rates by about 1 percentage point for the remainder of 2024.

Ahead of the release of the Consumer Price Index (CPI) data for July later on Wednesday, bullish bets reappeared in the world's largest bond market, indicating that traders are prepared for further gains as they expect the CPI data to show continued downward pressure on prices.

"To be honest, I think both sides have valid arguments," said Matthew Luzzetti, Chief US Economist at Deutsche Bank, referring to the debate over whether the Fed will cut rates by 25 basis points or 50 basis points in September. "Their rates are restrictive, and inflation data tells them there isn't as much upward inflation risk. Then, it depends on whether the economy is as resilient as we think."

On Wednesday, the policy-sensitive 2-year and 10-year US Treasury yields traded below 4%, hovering above the lows touched during last week's market turmoil.

On Tuesday, US PPI data rose less than expected, reflecting the first decline in service costs this year and continued easing of inflation pressures. This has made the market more optimistic about softer consumer-level inflation data, but it is also susceptible to unexpected developments.

In the past few trading days, open interest in some tenors has started to rise, consistent with increased long positions in new US Treasuries. Meanwhile, in the spot market, a bond client survey released by Morgan Stanley on Tuesday showed that client net long positions are at their highest level since December.

Economists expect the core and overall CPI indices for July to rise by 0.2% month-on-month, with George Catrambone, Head of Fixed Income at DWS Americas, stating that if the CPI data performs better than expected, it could scare off traders and force them to reduce their bets on a significant Fed rate cut.

On Tuesday, Atlanta Fed President Bostic stated that he wants to see "more data" before supporting a rate cut, emphasizing that he wants to ensure the Fed does not have to change course after starting to cut rates.

"The broader economy seems to be cooling off, while at the same time, we see inflation starting to visibly ease," said Mona Mahajan, Senior Investment Strategist at Edward Jones. "The current data does not suggest that the Fed is eager to cut rates by 50 basis points."

Following weak US employment data earlier this month, the bond market has clearly surpassed predictions of a 50 basis point rate cut by the Fed this year. Next, market participants will closely analyze Fed Chair Powell's speech at the annual central bank symposium in Jackson Hole later this month, as well as the next US non-farm payroll report in early September Gregory Faranello, Managing Director of Interest Rate Trading and Strategy at AmeriVet Securities, stated:

"If the inflation data is strong, the Fed will cut interest rates by 25 basis points in September. However, if the unemployment rate rises again, and the non-farm payroll report next month weakens further, it may distort the market's pricing of the Fed's interest rate cut."