Will interest rates be cut in November, and by how much? Tonight's inflation data is crucial

Before the release of last week's non-farm data, no one would have expected tonight's inflation data to be so important. Because it will provide clues for the Fed's last two interest rate decisions this year and validate whether last month's aggressive rate cut was a big mistake.

Originally, the market optimistically believed that when the Fed initiated a loose cycle last month, inflation had already been defeated, and it was expected to cut interest rates at least twice by the end of the year. Therefore, people were generally tolerant of slightly higher CPI data and excited about lower-than-expected CPI.

However, the U.S. non-farm payroll report released last Friday shattered this optimistic expectation. The increase in employment far exceeded expectations, the unemployment rate unexpectedly dropped to 4.1%, and wage growth increased year-on-year. People began to worry about an overheating economy, and former U.S. Treasury Secretary Summers even warned that the Fed's "50 basis point rate cut in September was a mistake."

Now, CPI data needs to be softer than before to alleviate market concerns; higher-than-expected inflation may reverse the current "golden-haired girl" narrative and have a greater negative impact on the market.

Market Expects CPI to Continue Cooling in September

Tonight, all eyes in the market are focused on this heavyweight inflation data. Once inflation picks up, the market is concerned that the Fed may pause its rate cuts in November.

Currently, the market's expectations for September CPI data are:

• CPI to rise by 0.1% month-on-month, lower than the 0.2% increase last month;
• Core CPI to drop to 0.2% month-on-month, also lower than the previous 0.3%;
• On a year-on-year basis, CPI to decrease from 2.5% to 2.3%, the lowest increase since the beginning of 2021;
• Core CPI is expected to remain unchanged for the third consecutive month, rising by 3.2% year-on-year.

Goldman Sachs predicts that airfare prices will drop by an average of 3.4%, and used car prices will drop by an average of 1.1%, which will weaken inflation pressure in September.

Housing inflation is also expected to ease, with owner's equivalent rent expected to rise by 0.35% and primary rent rising by 0.31%, compared to the significant increases in July and August.

It is worth noting that in recent months, core CPI has been stubborn due to the soaring prices of car insurance. If this trend continues, the stickiness of core CPI may further intensify. Goldman Sachs predicts that car insurance prices will rise by another 0.7% in September.

In addition, the tension in the Middle East leading to rising energy costs, as well as the strike by dockworkers along the U.S. East Coast and the Gulf of Mexico last week, could cause inflation to resurge.

Looking ahead, Goldman Sachs expects the monthly core CPI inflation rate for the remaining time of this year to be around 0.20-0.25%, and the rebalancing of the automotive, housing rental, and labor markets in 2024 will further reduce the inflation rate, but the catch-up inflation in healthcare and car insurance will offset the impact of inflationJerome Powell made a speech earlier this week, expressing increasing confidence in the return of inflation to the 2% target, and believed that the 50 basis point rate cut in September reflected this confidence. He stated that before the Fed meeting in November, more employment and inflation reports will be considered.

Controversy still exists over the rate cut in November, inflation risks will shake market optimism

The meeting minutes released overnight show that there is still disagreement among Fed policymakers on the aggressive rate decision in September, further lowering expectations for rate cuts. Some Fed officials have recently stated that they are currently inclined to slow down.

"People are worried that the Fed may pause the rate cuts at the next meeting." said Bryce Doty, bond fund manager at Sit Investment Associates, "If employment remains strong, the only factor that could continue to push the Fed to cut rates is moderate CPI."

"Even if core CPI unexpectedly rises, we believe the September report will not change the FOMC's view that inflation is trending downward." wrote Anna Wong, Chief U.S. Economist at Bloomberg Economics, in a report on Thursday.

She expects that after the Federal Open Market Committee cut rates by half a percentage point last month, there will be a 25 basis point rate cut in November.

Goldman Sachs analyst Lou Miller stated:

"The 10-year yield has risen 45 basis points from its low, if inflation shows more stubborn signs, it may gradually change the current 'golden-haired girl' optimistic expectations, that is, the Fed will cut rates in the case of strong U.S. economic growth and improving corporate profit trends."

Goldman Sachs strategist Dominic Wilson stated:

"The market's reaction to rising inflation may be more severe than the reaction to falling inflation, and as a result, the stock market may experience a downward trend."

He added that although the data may trigger a market decline, the overall impact may not be as significant as previously expected. There are two specific reasons for this:

Firstly, as the market has already adjusted its expectations for future interest rates, especially a nearly 50 basis point increase in the mid-term rate expectations for 2025, this means that the market has already absorbed some expectations of future rate hikes, which may reduce the impact of future data on the market.

Secondly, there are more concerns in the market about future data, which may make the actual market consensus more conservative than it appears on the surface. And if the actual data performs better than expected, it may be more reassuring, because the "fear" may have already been digested in advance.