Why is the market reducing bets on interest rate cuts despite CPI being lower than expected?

On Wednesday, data released showed that the US July non-seasonally adjusted CPI year-on-year recorded 2.9%, this is the first time it has been below 3.0% since March 2021, lower than the general expectation; the non-seasonally adjusted core CPI year-on-year recorded 3.2%, still the slowest growth since early 2021, with a monthly rate of 0.2%.

After the US CPI was announced, the probability of the Fed cutting interest rates by 50 basis points in September slightly decreased to 43.5%.

Some economists believe that the labor market must deteriorate significantly for the Fed to cut interest rates by 50 basis points. Win Thin, Global Head of Currency Strategy at BBH, stated that it is too early to draw conclusions now, but the market trend so far indicates that following the release of US PPI data yesterday, the market expected the overall CPI data to be lower than expected. Therefore, for a market with a dovish bias, today's results are disappointing.

Gennadiy Goldberg, US Interest Rate Strategist at TD Securities, stated that the surprising aspect of the CPI report is the accelerated rise in rents, which is why the market reacted somewhat disappointed. The "owners' equivalent rent" data for June hit the lowest level since 2021, but this indicator accelerated to 0.36% in July. Nevertheless, this is still lower than the growth rates usually seen in the past few years. As this indicator carries slightly less weight in core PCE, it means that the inflation indicator favored by the Fed will be slightly lower than the CPI. This will certainly prompt the Fed to cut rates in September, but it does not necessarily increase the likelihood of a 50 basis point cut. The Fed is likely to choose to slow down the pace at the first rate cut, and then consider a larger rate cut later.

Rusty Vanneman, Chief Investment Officer at Orion, stated that considering today's CPI and yesterday's PPI data, as well as short-term inflation expectations based on market and survey data falling to multi-year lows, the likelihood of a Fed rate cut in September remains high, but the market believes that inflation is trickier than the Fed expected, hence reevaluating the possibility of a 50 basis point rate cut in September.

With inflation below the psychological threshold of 3%, investors' focus can clearly shift from inflation to economic growth and employment. For Powell and his colleagues, substantial further weakening in the labor market will be more important than the "okay, but not great" CPI data.

Analysts believe that CPI data has a relatively small impact, and the extent of rate cuts is still more influenced by employment data. Jack Mcintyre, Investment Manager at Brandywine Global, said: "US CPI data is important, but in terms of its impact on the market, it may rank third in the hierarchy of economic data - employment numbers, retail sales, and inflation, so it is not as important." "He said,"This obviously gives the Fed room to cut interest rates, so it tells you that inflation is moving in the right direction. The longer the Fed does nothing, the more restrictive monetary policy will be."

He believes that inflation data cannot determine the extent of rate cuts, and what will determine the extent of rate cuts will be growth-oriented economic statistics, especially labor statistics and employment figures.

Of course, some analysts believe that the reasons for a 50 basis point rate cut in September are very clear. For example, deVere Group analyst Nigel Green said that the reason for a significant 50 basis point rate cut in September is clear, as it is to send a strong signal that the Fed is serious about steering the U.S. economy away from the edge of recession