U.S. August CPI rose by 2.5% year-on-year, hitting a three-and-a-half-year low, while the core month-on-month increase unexpectedly rose to 0.3%

Despite the overall inflation in the United States moving solidly towards the Federal Reserve's target, the stickiness of core inflation exceeded market expectations, significantly cooling expectations for a 50 basis point rate cut by the Federal Reserve next week.

Data released by the U.S. Bureau of Labor Statistics on Wednesday showed:

The U.S. CPI in August rose by 2.5% year-on-year, in line with expectations, a significant decrease from the previous value of 2.9%, marking the fifth consecutive month of slowing down to the lowest level since February 2021, with a 0.2% month-on-month increase, in line with expectations and the previous value.

The U.S. core CPI in August (excluding volatile food and energy costs) rose by 3.2% year-on-year, in line with expectations and the previous value, having slowed down for the fourth consecutive month, with a 0.3% month-on-month increase, slightly higher than the expected and previous value of 0.2%.

After the data was released, traders reduced their bets on a significant rate cut by the Federal Reserve in September, leading to a short-term rise in the U.S. dollar index and bond yields, while U.S. stock futures declined in the short term.

Housing and transportation costs support inflation, while energy and used car prices continue to decline

In August, the core inflation rate in the United States unexpectedly rose, mainly due to accelerated growth in housing and transportation costs. Specifically:

Housing costs rose by 0.5% month-on-month, with the Owners' Equivalent Rent Index (OER) rising by 0.5%, the largest increase since January, the Rent Index rising by 0.4%, and the Lodging Away from Home Index rising by 1.8%, compared to a 0.2% increase in July.

Airfare prices rose by 3.9% month-on-month in August after five consecutive months of decline, although airfares are still cheaper than the same period last year.

Prices of used cars and trucks fell by 1.0% in August following a 2.3% decline in July; new car prices remained relatively stable.

Healthcare costs fell by 0.1% in August, following a 0.2% decrease in July.

Furniture prices fell by 0.3%, reversing the 0.3% increase in the previous month.

Energy prices fell by 0.8% in August after remaining flat in July, with gasoline prices falling by 0.6% month-on-month, electricity prices dropping by 0.7%, and natural gas prices declining by 1.9%.

In the automotive sector, used car prices fell by 1.0%, easing from the 2.3% decline in the previous month; while airfare prices rose by 3.9%, reversing a 1.2% decline in the previous month. After rising by 1.2% in July, car insurance costs increased by 0.6%

September Rate Cut by 25 Basis Points, a Done Deal?

Due to an unexpected increase in core inflation on a month-on-month basis, currently, according to CME Group tools, traders expect the likelihood of a 50 basis points rate cut in September to be less than 20%, while the likelihood of a 25 basis points rate cut has risen to 83%.

Analysts tend to be cautiously optimistic about this inflation report, with some previously expecting the inflation rate to continue to decline more than expected.

Josh Jamner, an investment strategy analyst at ClearBridge Investments, stated that today's release "will disappoint the short-term bond market, as these markets have already priced in a 250 basis points rate cut by the end of 2025".

Today's data is slightly unfavorable, but it will not prevent the Fed from starting to normalize monetary policy next week, but it may redefine the future rate path.

There are further signs that inflation may be trickier than previously thought, which could lead to a slower and smaller rate cut cycle.

Brian Coulton, Chief Economist at Fitch Ratings, bluntly pointed out:

This to some extent reminds us not to get too excited about the improvement in inflation data over the past few months.

Chris Zaccarelli, Chief Investment Officer at Independent Advisor Alliance, wrote in a report that the Fed has now given the "green light" for a 25 basis points rate cut next week.

Some may be disappointed that the inflation data did not fall below expectations, which could provide more room for the Fed to cut rates by 50 basis points, but most Fed speakers have expressed their desire for a slow rather than aggressive rate cut.

Chris Larkin, a trader at Morgan Stanley, stated that the market generally expects the Fed to cut rates by 25 basis points next week, and today's CPI data more or less aligns with the expectation of a 25 basis points rate cut. Investors hoping for a larger rate cut may be disappointed, but as inflation seems to be under control, the market may shift its focus back to economic growth, especially the employment situation.

Chris Low, an analyst at FHN Financial, believes that describing tonight's CPI as a "bad report" is a mistake.

Some sectors saw significant increases, but the most concerning OER and airfare prices rose after several months of positive news. Meanwhile, inflation is slowing down, with the CPI inflation rate year-on-year showing a decline as clear evidence Morgan Stanley Asset Management analyst David Kelly told Bloomberg that the August CPI data is more of a disturbance for next week's interest rate decision, as the core data is slightly higher than this month's expectations. However, he added that inflation has cooled to "room temperature" - indicating that there is no "significant" inflation issue.

Overall, I think it's well controlled. It seems we haven't seen any deflation risks