Heavyweight CPI inflation data is about to be released. Will the Federal Reserve announce a 50 basis point rate cut?

According to the Zhitong Finance and Economics APP, the softness in the labor market has left Wall Street anxious ahead of the latest inflation data on Wednesday, which will provide more clues for the Fed's interest rate decision next week.

Recent fluctuations in inflation that appeared earlier this year have gradually eased in a favorable direction, allowing the Fed to focus on the health of the labor market and opening the door to the first rate cut in four years.

Fed Chairman Powell hinted at a rate cut at the policy meeting on September 17-18 during his speech at the Jackson Hole Economic Symposium in August. However, the exact amount of rate cut by the Fed remains a hot topic of discussion on Wall Street.

Oscar Munoz, Head of U.S. Macro Strategy at TD Securities, said, "My view is that they will start with a 25 basis point rate cut next week."

The Fed's short-term policy rate is currently at its highest level in twenty years, raising borrowing costs for households, businesses, and even the U.S. government. The hope is that by maintaining high rates, inflation can be contained without harming the economy.

According to the Chicago Mercantile Exchange (CME) FedWatch tool, traders estimated on Tuesday that there is a 70% probability of a 25 basis point rate cut at the upcoming meeting, while the probability of a 50 basis point rate cut is around 30%.

Focus on CPI

Tom Essaye, founder of Sevens Report Research, stated in a report on Monday, "Wednesday's Consumer Price Index (CPI) may be a key factor in determining whether the Fed will cut rates by 50 basis points or 25 basis points next week. In general, the weaker the data, the more favorable it is 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 rate cut expectations."

According to a survey of economists by foreign media, the Consumer Price Index for August is expected to rise by 0.2%, bringing the year-on-year inflation rate down from 2.9% in July to 2.6%. The core inflation rate (excluding volatile food and energy prices) is also expected to rise by 0.2%, maintaining a year-on-year rate of 3.2%.

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

Diaz noted that the importance of August's CPI data is slightly lower than recent inflation data, but he will still focus on the performance of housing and the "super core" components to assess the Fed's likely decision on interest rates.

Munoz of TD Securities pointed out that although inflation has not returned to the Fed's annual 2% target, stable market conditions can be maintained as long as extreme situations are avoided in the August CPI data. "We have come a long way," Munoz said, referring to the stock market, as the market expects the Fed to make significant rate cuts this year and even until 2025.

Despite the weakness in the U.S. economy and poor performance in September, as of the Tuesday close, the S&P 500 index has risen by 15.2% this year, the Dow Jones Industrial Average has risen by 8.1%, and the Nasdaq Composite Index has risen by 13.4% Diaz supports a larger rate cut due to his concerns about the labor market. Although the trend of monthly job additions continues, early employment report data was unexpectedly revised downward, and the new job positions are mainly concentrated in the government, healthcare, and education sectors - which are usually less associated with the economic cycle and less affected by economic forces. "I think there is indeed reason to be concerned about the job market."

Stock Market and Employment

Since early August, the U.S. stock market has experienced significant volatility, partly due to the unexpectedly weak July employment report, alerting investors to a slowdown in the labor market. Subsequently, the lingering question arose whether the Federal Reserve waited too long to start cutting rates.

In his speech at the end of August at Jackson Hole, Powell downplayed the issue of inflation and indicated that the Fed has limited tolerance for further weakness in the labor market.

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

Chandler believes that if the August non-farm payroll report released on September 6 does not pave the way for a 50 basis point rate cut, then "CPI data also seems unlikely to play a decisive role."

He further explained that if the core inflation rate in August is in line with expectations at 0.2%, it may not be enough to prompt action from the Fed. But if there is an unexpected inflation deceleration, with a monthly inflation rate between -0.3% and -0.5%, "this could push us towards a 50 basis point rate cut, especially if this data is concentrated in the service part of the CPI."

Looking ahead to post-September, federal funds futures on Tuesday showed that the market expects borrowing costs to drop by a full percentage point or more by December, with a potential decline of 2.5% by the end of 2025.

Diaz of Brown Advisory stated that this pricing seems to reflect the market's expectation of the economy being "somewhere between a soft landing and a recession." He added that investors should not rule out the possibility of further rate cuts.

On the other hand, Chandler of Bannockburn believes that the current rate cut expectations reflect traders' tendency to "push things to the extreme." He added that the labor market may be at a turning point, which could lead to a significant contraction in employment