Tonight, CPI may be a "blank sheet", is the extent of the Fed rate cut still a mystery?

The upcoming inflation data on Wednesday should provide more clues for the magnitude of the Fed's rate cut.

Oscar Munoz, Chief US Macro Strategist at Dohmen Securities, said, "I think they will cut rates by 25 basis points next week, but I wouldn't be too opposed to a 50 basis point cut either."

The Fed's short-term policy rate has been at its highest level in nearly two decades, raising borrowing costs for households, businesses, and even the US government. People hope that the increased rates can help curb inflation without damaging the economy.

According to the CME Group's FedWatch tool, traders on Tuesday estimated a 70% probability of a 25 basis point rate cut at the upcoming meeting, while the probability of a 50 basis point cut was close to 30%.

CPI Takes Center Stage

Tom Essaye, Founder of Sevens Report Research, stated in a report on Monday, "Wednesday's CPI could be a key factor in determining whether the Fed cuts rates by 50 basis points or 25 basis points next week. Overall, the weaker the number, the better for the market, and the greater the likelihood of a 50 basis point rate cut by the Fed. Regardless of recent growth data, the market generally welcomes larger expected rate cuts."

According to a survey of economists by The Wall Street Journal, it is expected that CPI in August will increase by 0.2% month-on-month, bringing the annual inflation rate down from 2.9% in July to 2.6%. The core rate, which excludes volatile food and energy prices, is also expected to rise by 0.2% month-on-month, with the year-on-year growth rate remaining unchanged at 3.2%.

Chris Diaz, Portfolio Manager and Co-Head of Global Taxable Fixed Income at Brown Advisory, said in an interview, "I don't know why they wouldn't cut by 50 basis points, but that's a big debate in the market."

Diaz mentioned that Wednesday's August CPI is not as crucial as recent inflation readings. However, he will still focus on housing costs and data from the "super core" section to look for clues on the direction of Fed rate policy.

Munoz of Dohmen Securities stated that although inflation has not returned to the Fed's 2% annual target, the August CPI reading only needs to avoid extreme scenarios to control market volatility.

Munoz said, " The risk is that the stock market has already rebounded significantly due to expectations of a substantial rate cut by the Fed this year and until 2025 ."

Diaz expressed support for a larger rate cut due to his concerns about the job market. Despite monthly job gains in the economy, previous payroll estimates saw an unexpected downward revision, and new job positions are concentrated in non-cyclical sectors such as government, healthcare, and education—areas typically less correlated with economic conditions.

Diaz said, "I do think there are reasons to be concerned about the job market."

Stock Market and Employment

Since early August, the stock market has been volatile due to the unexpectedly weak employment report in July, which raised concerns among investors about a slowing job market. This has also sparked questions about whether the Federal Reserve waited too long to pivot towards rate cuts.

Of note in Powell's speech at Jackson Hole at the end of August was his downplaying of inflation concerns, while indicating the central bank's limited tolerance for further weakness in the job market.

Marc Chandler, Chief Market Strategist at Bannockburn Global Forex, said, "Powell was very clear in his Jackson Hole speech that the focus has shifted, with the job market becoming more important than inflation."

Chandler said over the phone, "If the August nonfarm payrolls report released on September 6 does not pave the way for a 50-basis-point rate cut by the Fed, 'then it seems unlikely that the CPI data will do so either.'"

He noted that the expected 0.2% month-on-month increase in core CPI for August is insufficient to support a rate cut. But if an unexpected slowdown occurs, causing the reading to drop by 0.3% to 0.5%, 'it could prompt us to move towards a 50-basis-point rate cut,' especially if this slowdown is concentrated in the services sector of the CPI.

Looking beyond September, federal funds futures on Tuesday implied that borrowing costs could drop by a full percentage point or more by the end of December, and by 2.5% by the end of 2025.

Diaz of Brown Advisory noted that pricing seems to reflect a market positioned between a "soft landing" and a "recession." "We don't think this is excessive in the long run," he said, adding that investors should not rule out the possibility of more rate cuts.

On the other hand, Chandler of Bannockburn believes that the current probability of rate cuts reflects traders' tendency to 'push things to the extreme.' However, he added, "There are concerns about a turning point that could lead to a sharp contraction in the job market."