The August Consumer Price Index (CPI) report delivered a blow to hopes of a quick and aggressive monetary easing by the Federal Reserve, sending a mixed message to investors. While headline inflation, which includes the price of food and energy, slowed to a 2.5% annual increase, its lowest reading since February 2021, core inflation remained stubbornly high. This core inflation, which excludes the more volatile food and energy components, advanced by 0.3% on a monthly basis, exceeding the expected 0.2% increase. Year-over-year, core CPI remained elevated at 3.2%, significantly above the Fed’s 2% target.
The persistence of core inflation has effectively dashed any remaining hopes of a more aggressive 50-basis-point rate cut. Market expectations for such a cut have dramatically decreased to just 15%, a significant drop from 34% the previous day, according to CME FedWatch data. The most likely scenario now points to a more measured 25-basis-point reduction in the federal funds rate at the upcoming Federal Open Market Committee (FOMC) meeting on Sept. 18.
Ed Yardeni, president of Yardeni Research, cautioned investors about their optimism, highlighting that they are pricing in two more rate cuts before the end of the year, including one as large as 50 basis points. He warned that these expectations could be dashed by stronger-than-expected economic indicators in the future. Yardeni explained that this current easing cycle is different from past ones. Historically, the Fed has aggressively cut rates in response to financial crises that quickly spiraled into credit crunches and recessions. However, this time, the central bank is taking proactive measures to prevent a downturn, suggesting that fewer rate cuts might be necessary to achieve its objectives.
The upcoming Producer Price Index (PPI) report for August, scheduled for release on Friday at 8:30 a.m. ET, is now a key focus for the Fed. This report will provide valuable insights into inflation pressures among U.S. producers. Economists expect the PPI for final demand to continue its downward trend, decelerating from 2.2% year-over-year in July to 1.8% in August. This would mark the second consecutive month of declining annual producer inflation. On a month-over-month basis, the PPI is projected to show a modest increase of 0.1%, matching July’s reading. The core PPI, which excludes volatile food, energy, and trade service prices, is anticipated to edge up slightly to 0.2% monthly, accelerating from an unchanged reading in July. The annual core PPI is projected to rise from 2.4% in July to 2.5% in August.
In essence, the market’s optimistic view that the Fed can aggressively cut rates could face further challenges if the August PPI report reveals persistent price pressures among U.S. producers. The next few weeks will be crucial for gauging the Fed’s stance on monetary policy as the central bank navigates the delicate balance of taming inflation without jeopardizing economic growth.
