CPI is lower than expected, so why is the market reducing its bets on interest rate cuts?

Data released on Wednesday showed that the annual rate of the US unadjusted CPI in July was 2.9%, which was the first time it was below 3.0% since March 2021, lower than generally expected; the annual rate of the unadjusted core CPI was 3.2%, still the lowest growth rate since the beginning of 2021, and the monthly rate was 0.2%.

After the release of the US CPI, the probability of the Federal Reserve cutting interest rates by 50 basis points in September dropped slightly to 43.5%.

Some economists believe that the labor market must deteriorate significantly before the Federal Reserve can cut interest rates by 50 basis points. Win Thin, head of global market strategy at BBH, said that it is too early to draw conclusions, but the market trend so far shows that after the release of yesterday's US PPI data, the market expects the CPI data to be lower than expected overall. Therefore, for the market with dovish expectations, today's results are disappointing.

Gennadiy Goldberg, head of US interest rate strategy at TD Securities, said that what was surprising in the CPI report was that rents were accelerating, and that was why the market reaction was somewhat disappointing. June's "owner equivalent rent" data hit the lowest level since 2021, but the indicator accelerated to 0.36% in July. Still, this is lower than the growth rate usually seen in the past few years. Since the indicator has a slightly lower weight in the core PCE, it means that the inflation measure favored by the Fed will be slightly lower than the CPI. This will definitely make the Fed cut interest rates in September, but it does not necessarily increase the possibility of a 50 basis point cut. The Fed is likely to choose to slow down the first rate cut and then consider a larger rate cut.

Rusty Vanneman, chief investment officer of Orion, said that considering today's CPI and yesterday's PPI data, as well as market-based and survey-based short-term inflation expectations have fallen to multi-year lows, the Fed's September rate cut is still very likely, but the market believes that inflation is a little trickier than the Fed expected, so the possibility of a 50 basis point cut in September is re-evaluated.

With inflation below the psychological mark of 3%, investors' focus can obviously shift from inflation to economic growth and employment. For Powell and his colleagues, a further weakening of the labor market will be more important than a "OK, but not great" CPI data.

Analysts believe that the CPI data has less impact, and the extent of the rate cut is still more affected by the employment data. Jack Mcintyre, investment manager of Brandywine Global, said: "The US CPI data is important, but in terms of its impact on the market, it may rank third in the hierarchy of economic data - that is, employment, retail sales and inflation, so it is not so important." He said, "This obviously gives the Fed room to cut interest rates, so it tells you that inflation is moving in the right direction. The longer the Fed does nothing, the more restrictive monetary policy will be." He believes that inflation data cannot determine the extent of the rate cut. The extent of the rate cut will be determined by growth-oriented economic statistics, especially labor statistics and employment.

Of course, some analysts believe that the reason for a 50 basis point rate cut in September is obvious. For example, Nigel Green, an analyst at deVere Group, said that the reason for a sharp 50 basis point rate cut in September is obvious because it is necessary to send a strong signal that the Federal Reserve is serious about guiding the US economy away from the brink of recession. Risk warning and disclaimer: The market is risky and investment should be cautious.

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