US CPI Tonight: Could It Severely Damage September Rate Hike Expectations?

Whether the Federal Reserve will raise interest rates in September may be revealed tonight.

The US Bureau of Labor Statistics will release the July CPI data at 8:30 AM ET on Wednesday (8:30 PM Beijing time). The market consensus expects headline CPI to rise by 0.1% month-over-month, and core CPI to rise by 0.2% month-over-month, with annual rates dropping to 3.4% and 2.5%, respectively.

Following last week's unexpectedly soft non-farm payroll data, this report will serve as a key litmus test for September rate hike expectations. If the data is mild, the market may further reduce the probability of a September rate hike; if the data is hotter than expected, it will place greater pressure on the already hawkish Federal Reserve.

Currently, interest rate futures are pricing in approximately a 50% probability of a September rate hike, a so-called "coin flip." Last week's non-farm payroll data showed a decrease of 23,000 jobs in July, which temporarily cooled rate hike expectations, but a subsequent rebound in oil prices pushed the probability back to equilibrium. Meanwhile, at the Fed's July meeting, three governors voted in favor of a rate hike, and several non-voting members explicitly expressed a tendency towards tightening policy, giving significant weight to hawkish voices within the committee. Tonight's CPI data will directly influence the tilt of this balance.

Mild Reading Likely, But Still Above Target

Combining forecasts from institutions such as Goldman Sachs and Pantheon Macroeconomics, the upcoming CPI data is likely to fall within the expected range and is unlikely to replicate the significant volatility seen in last month's report.

Goldman Sachs expects July core CPI to rise by 0.19% month-over-month, with an annual rate of approximately 2.47%, both slightly below market Consensus Estimates; headline CPI is expected to rise by only 0.05% month-over-month, with an annual rate of around 3.35%. The decline in energy prices (-2.0%) is the main driver suppressing overall inflation, while food prices are expected to rise moderately by 0.2%.

At the component level, Goldman Sachs expects used car prices to rise by 0.5% month-over-month and new car prices to rise by 0.1%, but auto insurance prices to fall by 0.5%; regarding housing components, Owners' Equivalent Rent (OER) is expected to rise by 0.23% month-over-month, and rents by 0.16%, continuing the recent trend of slowdown; travel services show divergence, with airfare prices expected to rise by 2.0% and hotel prices expected to fall by 1.0%, partly because the demand boost from the World Cup has gradually faded.

Pantheon Macroeconomics expects core goods prices to rise by 0.18% month-over-month, the largest increase since last September, partly influenced by Apple (AAPL) raising prices on most hardware products by 15% to 30% starting June 25. However, weakness in the services component will offset this—the firm expects airfare prices to fall by 1.5% month-over-month, accommodation prices to fall by 1.0%, auto insurance to continue its downward trend, and energy commodity prices to fall by 2.6%, dragging down the monthly headline CPI rate by approximately 11 basis points.

Fed Stance: Hold Steady, But Hawkish Noise Growing

Joe Brusuelas, Chief Economist at RSM, stated that if July CPI is close to expectations, "the majority of the committee will choose to ignore supply-side shocks, and the FOMC will keep interest rates unchanged for the remainder of the year," providing some buffer for Fed Chair Warsh, who has faced continuous policy pressure since taking office in May.

However, hawkish forces within the Federal Reserve are accumulating. Cleveland Fed President Beth Hammack, one of the three governors who voted for a rate hike at the July meeting, stated on Monday that multiple rate hikes might be necessary, emphasizing that "a single 25 basis point adjustment would likely have quite limited impact on the economy." Additionally, non-voting members Schmid and Musalem indicated that they would have been inclined to support a rate hike at the July meeting. Although Fed Chair Warsh acknowledged that current tightening financial conditions are substituting for part of the Fed's work, and that the July employment data and its downward revisions indeed suppressed recent tightening expectations, he did not explicitly rule out the possibility of further rate hikes.

Bank of America maintains its forecast of three rate hikes in the coming months. Economists at the bank pointed out in a client report that the July employment report "did not change the overall picture of the labor market," and the Fed's policy reaction function remains "heavily tilted towards inflation data." The bank warned that if the average monthly core CPI over the next two months reaches 0.25%, "the Fed will almost certainly begin raising rates in September"; if the average is below 0.2%, rate hikes will be delayed; if it falls between the two, September remains a "50-50" proposition.

Stocks and Bonds Under Pressure, Equity Sentiment Indicator Flashes Red

J.P. Morgan's Market Intelligence team provided a scenario analysis for this CPI data:

• If core CPI month-over-month exceeds 0.30%, the S&P 500 Index is expected to fall by 1.5% to 2.5%, with a 5% probability;
• If it falls within the 0.25% to 0.30% range, the index is expected to fall by 0.5% to 1.25%, with a 25% probability;
• If it falls within the 0.20% to 0.25% range (the most likely scenario, approximately 40%), the index is expected to rise by 0.25% to 0.75%;
• If it is below 0.20%, the gain could expand to 0.5% to 2%. Overall, the bond market's reaction to inflation exceeding expectations will be more severe than that of the stock market.

Notably, the implied volatility for the day, priced using options expiring on August 12, is approximately 0.9%, slightly below the recent average of about 1.1%, indicating that the market does not expect extreme results from tonight's data.

A team led by Wells Fargo analyst Ohsung Kwon warned investors to arrange hedging positions before the CPI release. The bank's sentiment indicator currently reads 1.4, placing it in the strongest "sell" signal range since January 2018. "We believe hedging costs are low and prefer to hedge against the risk of hotter-than-expected data," the analysts wrote. "If CPI exceeds expectations, the market narrative will quickly shift to stagflation concerns, especially against the backdrop of weak employment data last week." However, Wells Fargo also noted that Q2 corporate earnings grew by 30% year-over-year, beating market expectations by 8%, marking the strongest growth in over four years, which still provides some support to the stock market.

Longer-Term Concerns: AI Inflation and Market Structural Signals

Although the short-term inflation outlook is relatively mild, Andrew Lapthorne, an analyst at Societe Generale, pointed out that the structure of the stock market is sending warning signals. The bank's equity inflation proxy index, constructed based on developed market stocks most correlated with inflation, has significantly outperformed the MSCI World Index over the past 12 months, rising by a cumulative 71%. Lapthorne stated:

"The market no longer expects the contradictory combination of 'strong earnings growth + rate cuts,' but rather believes that such strong earnings growth is usually accompanied by a need for rate hikes."

Meanwhile, commodities related to the AI supply chain are facing upward pressure. It is reported that soaring memory prices could push up core PCE by 0.5 percentage points. Goldman Sachs expects the monthly core PCE rate in July to record a significant increase of 0.26%, partly reflecting the lagged effect of Q2 stock price gains transmitted to portfolio management service costs. Methodological adjustments for this item classification will be implemented at the end of September, at which point relevant data may be revised downward, but another revision in December may reintroduce strong correlations.

More Data Ahead, September Decision Still Uncertain

Even if tonight's CPI results are clear, the direction of the September rate hike is not yet settled. Before the FOMC meeting on September 16, the Federal Reserve will receive August non-farm payroll, August CPI, and August PPI data, while August PCE will only be released after the meeting. This means there is still ample room for policy expectations to shift in the coming weeks.

Overall, the most likely scenario is that the data meets expectations, which is neither sufficient to reignite the flame of a September rate hike nor enough for the market to completely dismiss tightening expectations. The final discretion in the hawk-dove debate still rests with subsequent data and Chair Warsh.

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