CPI is causing a stir again! Could it press the "pause button" on the Fed's rate cut?

Analysts at Bank of America stated that the September non-farm payroll data was good news for the market, but it gave investors more reasons to prepare for the latest inflation data.

The analysts mentioned that the blockbuster employment report last week added more pressure to this week's Consumer Price Index (CPI) data. If the data unexpectedly rises significantly, it is now more likely to trigger a wave of market volatility. They stated that the CPI data scheduled to be released on Thursday is "no longer an 'irrelevant event'".

In a report on Sunday, the analysts stated, "Following the strong employment report last Friday, we believe the importance of this week's CPI has increased. A fairly large surprise could bring uncertainty to the easing cycle and bring more volatility to the market."

They pointed out that option prices indicate that the S&P 500 index is expected to move 109 basis points, or slightly above 1%, when the CPI is released on Thursday, compared to the previous estimate of 91 basis points. This would exceed the three-month average volatility of 70 basis points for the index on the day of CPI release, marking the largest potential volatility caused by a CPI report since May.

On the positive side, the analysts stated that if combined with strong macroeconomic data, the stock market should be able to withstand a slight unexpected increase.

"As long as inflation does not surge, good news is good news for the stock market," the analysts said, adding that historically, when inflation falls, stocks and interest rates rise, and when inflation rises, the stock market and interest rates fall.

Economists predict that the CPI report will show a continued cooling of inflation last month, with a year-on-year increase of 2.3%, compared to 2.5% in August.

With the inflation rate easing slightly to the target level of 2%, the Federal Reserve is now increasingly focusing on the labor market after years of battling inflation. This shift is precisely the reason behind its decision to cut interest rates significantly by 50 basis points last month.

However, with the far better-than-expected September employment report, some economists have expressed concerns about inflation still being a worrisome issue. If this week's CPI data unexpectedly rises, the Federal Reserve may be forced to refocus on price pressures in the economy.

"The September CPI will be a key data point. If prices rise faster than expected, coupled with strong labor data, the likelihood of the Federal Reserve staying put at the November meeting will increase," said UBS economist Brian Rose in a report last Friday.

According to data from the CME FedWatch tool, after the September employment report was released, the probability of the Federal Reserve cutting rates by 50 basis points next month dropped from 33% to zero, and traders are not even fully pricing in a 25 basis point rate cut. Therefore, the CPI reading on Thursday has become more important for the Federal Reserve's next steps