On August 14, the US Bureau of Labor Statistics released economic data for July, in which the CPI rose by 2.9% year-on-year, marking the first fall back to the "2-digit" range since March 2021, slightly lower than market expectations. At the same time, the core CPI rose by 3.2% year-on-year in July, the lowest growth rate since the beginning of 2021, which was in line with market expectations.

US President Biden responded to the latest CPI data, acknowledging that further efforts are needed to address inflation, but also emphasized the substantial progress that has been made in controlling inflation. Biden pointed out that despite some improvements, the current price level is still high, especially for large companies, which have not performed well in price cuts.

In terms of monetary policy, according to CME's "Fed Watch", the market expects the Fed to cut interest rates by 25 basis points in September with a probability of 56.5%, while the probability of a 50 basis point cut is 43.5%. Moreover, Wall Street analysts generally believe that the July CPI data is unlikely to prompt the Fed to take more aggressive interest rate cuts, that is, a one-time 50 basis point rate cut.

The inflation level is lower than expected, and the market that rushed ahead is disappointed

The overall CPI in the United States in July was basically in line with expectations. The highly watched super inflation indicator (core service CPI excluding housing) rose by 0.2% month-on-month, but the year-on-year growth rate fell back to 4.73%. Inflation did not show a significant downward trend as the market expected, which slightly disappointed the market that rushed ahead.

In terms of sectors, car prices fell by 2.3%, airline fares fell by 1.2%, while car insurance costs rose by 1.2%, furniture prices rose by 0.3%, and transportation services rose sharply month-on-month. Commodity deflation continued to drag down the overall CPI. A series of data means that the growth rate of inflation in the United States is slowing down, and the Federal Reserve will soon cut interest rates, but the rate cut may not be as large as traders hope.

After the release of the US CPI data, traders lowered their expectations for the Federal Reserve to cut interest rates. Adam Button, an analyst at the financial website Forexlive, said that the market's pricing of the Fed's rate cut has dropped from 106 basis points before the data was released to 103 basis points. After the Fed's rate cut expectations were lowered, the US dollar index once rose in a short period of time, and then continued to fall, now at 102.31; the US 10-year Treasury yield rose in a short period of time and continued to fall, falling nearly 1% during the day, now at 3.822%; spot gold plunged in a short period of time, falling 0.6% during the day, now at $2450.69/ounce.

Is the rate cut in September a foregone conclusion?

Nick Timiraos, a reporter from the Wall Street Journal who is known as the "Federal Reserve's mouthpiece", wrote that the July CPI data paved the way for the Fed to cut interest rates at the next meeting. This view has been widely recognized by market analysts. The core CPI indicator can accurately reflect the underlying inflation trend, and as the US economy gradually slows down, inflation is generally on a downward trend. In addition, the weakness of the job market also provides strong support for the Fed's September rate cut.

Gennadiy Goldberg, head of U.S. interest rate strategy at TD Securities, pointed out that the acceleration of rent increases in the CPI report was unexpected, which may be the reason for the disappointment in the market reaction. The data was actually weaker than the market generally expected. The market is currently reassessing the possibility of a 50 basis point rate cut in September, and some believe that the inflation problem may be more difficult than the Fed expects.

At present, the biggest concern of traders is whether the Fed will choose a regular 25 basis point rate cut at its September meeting or take a more drastic rate cut. Jack Mcintyre, Global Investment Manager, emphasized that although the U.S. CPI data is crucial, its importance to the market is second only to employment and retail sales. He suggested that inflation itself is unlikely to determine the specific extent of the rate cut, but growth-oriented economic statistics, especially labor statistics and employment, will have a decisive impact on the Fed's decision.

With the July data of the Fed's preferred inflation indicator, the Personal Consumption Expenditure Index (PCE), to be released on August 30, and the August CPI report to be released on September 11, the release time of these two reports is only one week away from the Fed's September interest rate meeting, and they will directly affect the Fed's final choice in the decision to cut interest rates. The market's eyes are focused on these key data for insight into the Fed's next move.

Risk of US Recession

As inflation cools, signals from financial markets also suggest that the risk of a recession in the US economy is rising. Models from both Goldman Sachs and JPMorgan Chase show that although the probability of a recession is not high, the probability has increased significantly compared with previous forecasts. The main basis for this forecast is the trend of US bonds and the performance of stocks that are sensitive to the business cycle.

Goldman Sachs pointed out that the stock and bond market's expectations for a US recession are currently 41%, up from 29% in April. This adjustment in expectations reflects the market's bets on the aggressive pace of interest rate cuts that the Fed may take, as well as the lag in stock prices that are highly sensitive to the business cycle.

JPMorgan Chase's model also calculated that the probability of a recession is 31%, up more than 10 percentage points from 20% at the end of March. In addition, the probability of a recession reflected by the interest rate market is even higher than the stock market expectations in the Goldman Sachs and JPMorgan Chase models. Goldman Sachs' model shows that the 12-month forward change in the Federal Reserve's benchmark interest rate implies a 92% chance of a recession next year. JPMorgan Chase's model shows that the change in the five-year US Treasury yield indicates a 58% chance of an economic slowdown.

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