All eyes are on the US Bureau of Labor Statistics today, August 12, with the July inflation data due out at 8:30 A.M. Eastern Time, ahead of the US stock market’s opening bell on Wednesday.
Investors globally will be watching closely the release of the US CPI data for July. According to a WSJ survey of economists, the US CPI data for July are expected to show annual inflation eased to 3.4% in July from 3.5% in June.
The market’s reaction hinges on this number. Market sentiment is sensitive to US inflation rates; any increase or stickiness in inflation will be viewed negatively, while lower-than-expected inflation will be seen positively.
“A hot core print, or one that reveals sticky price pressures stemming from the inputs that go into Fed’ preferred PCE Index gauge, could lift the probabilities of a hike again, and weigh on equities. Meanwhile, a soft number could lower them, especially after last week’s major miss in US jobs data,” says Kyle Rodda, Senior Financial Market Analyst at Capital.com.
Inflation Watch
But this time, the usual playbook may not apply. How inflation played out in May and June may not matter now. In June, the US CPI dropped to 3.5% from 4.2% in May, primarily due to a significant decrease in oil prices following the US-Iran ceasefire announcement. That ceasefire, however, hasn’t held. The harsh reality is that the ceasefire has failed to materialize, and oil prices are approaching $90 amid escalating tensions in the Middle East.
Yet expectations haven’t caught up with that reality. Expectations for July are pointing towards further cooling. “June’s CPI looked like good news, cooling to 3.5%. But almost all of that came from falling energy prices, and oil has since risen more than 20%. So I wouldn’t count on Wednesday’s number cooling further. Consensus sits at 3.4% on the headline and 2.5% on core,” says Eshaan Lazarus, Co-Founder & CEO, 021 Trade.
US Federal Reserve Situation
This puts the Federal Reserve in a genuine bind. The Fed’s own committee is already split. In the last FOMC meeting, 3 out of 12 members voted for a rate hike. But, that was before the job market data was released. Last week’s monthly labor market report showed a decline of 23,000 jobs in July.
That makes the job of the US Fed difficult. The US CPI data for July may indicate if the US Federal Reserve will likely consider an interest-rate hike in its next FOMC meeting in September. But it’s too early to call it either way — a lot of economic data, including the job market, US CPI and PPI for August, arrives before the next FOMC meeting.
“The Fed is likely to act on the core figure for July on its own, rather than on the annual headline rate that will lead most of the coverage. A monthly core reading of 0.3% or higher would reopen the argument for a rate increase in September. A reading of 0.1% or lower would settle the case for leaving rates where they are,” says Shlok Srivastav, Co-founder and COO, Appreciate.
The jobs picture is pulling the Fed in the opposite direction. The latest job market data indicates deterioration in the employment sector, which may lead the US Fed to consider a rate cut. But that plan runs into a problem: if inflation continues to rise, a rate cut may not be feasible.
“The critical core inflation number is expected to have moderated to 2.5% in July (down from 2.6% in June), with headline inflation also tipped to ease,” says Rodda.
The likelihood of a rate cut at the September FOMC meeting has decreased from 65%, as was predicted early last week, with an equal split now: 50% anticipating no change at the current rates of 3.5%-3.75%, and the other half expecting a 25 basis points rate hike.
“The Fed makes this print matter more than usual. Three FOMC members voted for a hike in July, the committee’s most contested stretch in decades. A warm reading strengthens their case, and US stocks would likely fall in anticipation,” says Lazarus.
Where the Smart Money Is Actually Going
For markets, the path forward looks straightforward on paper. Any downtick or numbers as per expectations will be positive for the markets. Cooling of core inflation would also be especially welcome news for policymakers at the Federal Reserve.
But Lazarus isn’t convinced the good times will last. “The S&P 500 is up 13% this year and its dividend yield is at a four-decade low. Prices like these assume everything goes right. History shows they usually don’t. Other markets like South Korea and Japan offer much better investment options at this time. Almost every good investor I know is rotating in this direction,” says Lazarus.
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