Product prices as seen at Walmart.
Courtesy: Walmart
The news on Tuesday was good for inflation, and investors are hoping for even better news on Wednesday, when the Labor Department releases its July consumer price index report.
With the score down one, one to continue to confirm that the rise in prices earlier in the year was either a fluke or the last gasp of inflation, a positive CPI reading could mean the Federal Reserve is in a position to turn its attention to other economic challenges, such as the slowdown in the labor market.
“At this point, the inflationary pressure that we’ve seen building up has really dissipated significantly,” said Jim Baird, chief investment officer at Plante Moran Financial Advisors. “Inflation is hardly an issue at this point. There is this broad expectation that the worst is easily behind us.”
Like others on Wall Street, Baird expects the Fed in September to shift its focus from tightening policy to tackle inflation to a somewhat easier stance to head off a possible weakening of the jobs picture.
While consumers and business owners continue to express concern about high prices, the trend has indeed shifted. Tuesday’s producer price index (PPI) report for July helped confirm optimism that the elevated inflation numbers that started in 2021 and spiked again in early 2024 are on the back burner.
The PPI report, seen as an indicator of wholesale inflation, showed prices rose just 0.2% in July and about 2.2% from a year ago. That figure is now very close to the Fed’s 2% target and is indicative that the market’s push for the central bank to start cutting rates is about on target.
Economists surveyed by Dow Jones expected the CPI to show a similar 0.2 percent increase in both the all-in-one reading and the core measure that excludes food and energy. However, this is projected to show respective 12-month rates of 3% and 3.2% — well below their mid-2022 highs, but still well short of the Fed’s 2% target.
But investors are looking to the Fed to start cutting interest rates at its September meeting, given that inflation is weakening and so is the labor market. The unemployment rate has now risen to 4.3%, an increase of 0.8 percentage points over the past year that has triggered a time-tested recession flag known as the Sahm Rule.
“Given the focus on the relative weakening of the labor market, given the fact that inflation is coming down pretty quickly and I expect that to continue in the coming months, it would be surprising if the Fed didn’t start to move toward easing. very quickly, probably at the September meeting,” Byrd said. “If they don’t do it at the September meeting, the market is not going to take kindly to it.”
Concerns over Fed’s slow response
One short pickup a week Initial jobless claims, combined with other weakened economic metrics, briefly had some in the market looking for an emergency rate cut.
While that sentiment has eased, there is still concern that the Fed will be slow to ease, just as it was slow to tighten when inflation started to escalate.
Another benign inflation report “makes the Fed quite comfortable that it can shift its focus away from inflation and toward jobs,” said Tom Porcelli, chief U.S. economist at PGIM Fixed Income. “They could have shifted their focus from inflation to labor … months ago. There are cracks forming in the labor market landscape.”
Amid the twin realities of falling inflation and rising unemployment, markets are pricing in the absolute certainty of a rate cut at the September 17-18 Fed meeting, with the only question remaining being how much. Futures pricing is roughly split between a quarter-point or half-point cut, and leans heavily toward the possibility of a full percentage point cut by the end of the year, according to CME Group Calculations.
However, futures pricing has been quite far from flat for most of the year. Traders started the year anticipating a rapid pace of cuts, then went back to waiting for just one or two before the final swing in the other direction.
“I’m just as curious [Wednesday’s] inflation report like anybody else, but I think it would take a real extreme to change the pace of the Fed from 1) turning to jobs as its focus and 2) thinking seriously about cuts in September,” Porcelli said. “They should start aggressively. I can easily make the argument that the Fed cut 50 basis points just to get things started because I think they should have already cut. I don’t think they will do that. They will start it modestly.”
