Fed Signals September Rate Cut Amid CPI Expectations

Fed Signals September Rate Cut Amid CPI Expectations 

Nick Timiraos has published two previews of a September rate cut within 24 hours, just as expected, following the guidance of his Federal Reserve sources. The message is clear: while the Fed may not cut rates at the July FOMC meeting, it will strongly indicate that a cut in September is imminent. This also implies that tomorrow's CPI number is likely to align with or fall below estimates. After higher-than-expected results earlier in 2024, tomorrow's core CPI print is predicted to be the third consecutive miss of consensus estimates.

The market is already anticipating this outcome, as seen by a surge in call buying that pushed the VIX higher today. The only potential disruption to another post-CPI rally could come from someone leaking the real inflation number, which is believed to be much higher than the Bureau of Labor Statistics' adjusted figures, causing a market sell-off. However, the chances of this happening are minimal.

Before tomorrow's CPI report, scheduled for 8:30 am ET, the consensus expectations are: Headline CPI is expected to rise by 0.1% month-over-month in June, with forecasts ranging from 0.0% to 0.2%, and the core rate of CPI is seen rising by 0.2% month-over-month, matching the May reading. Most economists (55 out of 70) expect a 0.2% print, with a few predicting either 0.3% or 0.1%. A 0.0% core CPI print, possible if the owners' equivalent rent (OER) is very weak, could trigger a July rate cut.

Year-over-year expectations are for the headline rate to ease to 3.1%, down from 3.3% in May, with forecasts ranging from 3.0% to 3.3%. The core year-over-year rate is expected to maintain the May pace of 3.4%, with forecasts between 3.3% and 3.5%. Some expect a 3.3% or lower print due to unexpected decreases in housing inflation.

In their CPI preview, Goldman Sachs economists predict a 0.21% increase in June core CPI, corresponding to a 3.43% year-over-year rate, and a 0.11% increase in June headline CPI, corresponding to a 3.17% year-over-year rate. They expect a 0.17% increase in CPI core services excluding rent and OER and a 0.20% increase in core PCE in June.

Goldman highlights three key trends for this month's report: First, used car prices are expected to decline by 1.6%, reflecting continued adjustments to auction prices, while new car prices are expected to rebound to +0.2%. Second, car insurance prices will rise, but not as quickly as earlier in the year, with a 0.5% increase forecasted. Third, shelter inflation is expected to slow, with rent increasing by 0.36% and OER by 0.39%. However, stronger rent growth for single-family homes may cause OER to outpace rent in CPI by December 2024.

Elsewhere, Goldman expects unchanged airfares and a slight boost from consumer electronics categories. Looking ahead, Goldman predicts monthly core CPI inflation to remain in the 0.2-0.3% range for the next few months, settling around 0.2% by the end of 2024, with further disinflation from auto, housing rental, and labor markets, offset by catch-up inflation in healthcare and car insurance.

Fed Chair Powell noted at the ECB's Sintra Monetary Policy conference that disinflation trends are resuming, and the Fed has made progress on inflation. However, Powell emphasized the need for more confidence in easing price pressures before reducing interest rates. The FOMC's June meeting minutes reflected a similar cautious approach, with participants needing more favorable data to confirm sustained disinflation.

Money markets are pricing in 51 basis points of easing by year-end, implying two fully priced rate cuts, with the first cut likely by November and a high probability of a cut in September. The dovish pricing is driven by soft May inflation reports and a weaker labor market, among other factors. Another cool CPI print could further solidify the likelihood of a September cut, though a July cut is largely ruled out.

Bank of America expects another soft inflation report, which should give the Fed more confidence in the disinflationary trend. However, the potential downside risk to equities on a hotter CPI print outweighs the potential upside on a softer print. BofA advises hedging into the CPI data, especially with Q2 corporate earnings season starting soon. They believe the focus is shifting from an inflation/rate-driven market to a growth-driven market.

Goldman Sachs' traders predict a low implied move for tomorrow, suggesting that the CPI number is largely irrelevant as the Fed has accepted that inflation is slowing enough to permit a rate cut. JPMorgan also expects headline MoM CPI to print at +0.1%, in line with the consensus, with core MoM CPI slightly below the consensus at +0.19%.

Overall, the market is cautiously optimistic, expecting another soft CPI print to support the Fed's disinflationary narrative and potential rate cuts later in the year