Fed’s Rate Path Hinges on US CPI Data as Inflation Moderates

The financial world is focused on the upcoming release of the CPI data for September, as this key inflation metric could significantly influence the Federal Reserve's interest rate decisions in the coming months. With inflation moderating, the Fed is weighing its options as it seeks to balance price stability with economic growth. Expected to show a 2.3% year-over-year increase, down from August’s 2.5%, the latest CPI data will be pivotal in shaping the market’s expectations for future rate cuts. In this article, we will explore how this report could affect the Fed’s monetary policy and the broader market outlook.

Key Takeaways:

• The September CPI data is forecasted to show a 2.3% rise in inflation year-over-year, a slowdown from the 2.5% increase in August.

• Core CPI inflation is expected to hold steady at 3.2%, keeping the Federal Reserve cautious in its approach to future rate cuts.

• This inflation report will play a key role in shaping the Federal Reserve's next move on interest rates.

CPI Data Set to Moderate: What to Expect

The CPI data for September, due to be released on Thursday, is expected to show a slight moderation in inflation. Forecasts predict a 2.3% year-over-year increase, which would mark a slowdown from the 2.5% rise seen in August. Monthly inflation is expected to rise by just 0.1%, while core CPI, which excludes volatile food and energy prices, is projected to hold steady at 3.2%.

The CPI data has significant implications for the Federal Reserve’s rate decisions. A softer inflation reading could give the Fed room to continue its rate-cutting cycle, while any surprises to the upside might force the central bank to adopt a more cautious stance. TD Securities analysts have noted that headline inflation likely lost momentum, with energy prices providing relief. However, they warn that core goods prices could still contribute to inflation, particularly in areas like housing and services.

Fed Governor Adriana Kugler recently suggested that she would support additional rate cuts if inflation continues to cool as expected. However, other officials, such as St. Louis Fed President Alberto Musalem, have argued that easing monetary policy too soon could undermine the Fed’s credibility in fighting inflation, signaling the internal debate within the Fed.

How CPI Data Will Shape the Fed's Rate Path

The release of September’s CPI data comes at a critical juncture for the Federal Reserve, which has been carefully navigating its rate-cutting cycle. Following a 50-basis-point cut in September, the Fed faces growing pressure to ease rates further, but strong employment data has complicated the decision-making process. The September jobs report showed that the US labor market added 254,000 payrolls, significantly higher than the 150,000 expected by economists. This robust labor market, combined with sticky core inflation, has made the Fed’s path forward less clear.

According to market analysts, the latest CPI data will either reinforce or challenge current expectations for future rate cuts. Traders are currently pricing in an 81.1% chance of a 25-basis-point cut in November, with a smaller 18.9% chance that rates will remain unchanged. Citi economists expect the Fed to proceed with a modest cut in November, followed by a more substantial 50-basis-point reduction in December if inflation continues to moderate.

Bank of America’s equity strategist Ohsung Kwon highlighted the importance of this week's CPI report in determining the trajectory of US stocks. He noted that while inflation is expected to decelerate, any unexpected uptick could introduce volatility into the market. “Good news is good news for stocks as long as inflation doesn't flare up again,” Kwon wrote, stressing that a surprise increase in inflation could shake confidence in the Fed’s easing cycle.

Core Inflation Risks Remain Despite Moderating CPI Data

While the headline CPI data is forecasted to show a slowdown, core inflation risks persist. Housing costs, particularly owners’ equivalent rent, have remained stubbornly high, keeping core inflation elevated. Analysts at Citi and Bank of America have noted that rent inflation, combined with potential price increases in used cars and airfares, could lead to a firmer core inflation reading in September.

Despite these risks, most economists believe that the broader trend points toward disinflation. Bank of America analysts, Stephen Juneau and Jeseo Park, argued that while core CPI could come in stronger than recent months, the medium-term outlook for inflation remains positive. “A cooler labor market coupled with anchored inflation expectations should keep disinflation on track,” they wrote in a preview of the CPI data.

However, the analysts cautioned that upside risks remain, including rising oil prices and higher shipping costs, which could slow the disinflationary process. Any unexpected uptick in core inflation would likely raise questions about the Fed’s ability to cut rates aggressively, particularly if inflationary pressures continue to persist in key sectors like housing and services.