CPI falls largely in line; Traders continue to bet on the Fed moving 25 bps

In the August CPI report, headline inflation rose 0.2% month-over-month (MoM), matching analyst expectations, while year-over-year (YoY) inflation came in at 2.5%, slightly below the 2.6% estimate and down from July's 2.9%. Core CPI, which excludes food and energy, rose 0.3% MoM, marginally above the 0.2% forecast, while the YoY figure was in line with expectations at 3.2%, unchanged from July. The modest increase in core inflation was driven in part by a rise in shelter costs, with owners' equivalent rent increasing 0.5%, a notable acceleration from July's 0.36% gain.

Shelter continued to be a key contributor to inflation, with the 0.5% MoM rise in owners' equivalent rent signaling ongoing upward pressure in housing costs. Other notable components included a 0.8% drop in energy prices and a modest 0.1% increase in food prices. Despite some fluctuations in individual components, the overall CPI report suggests that inflationary pressures remain relatively contained compared to the highs seen last year.

Following the CPI release, markets reacted with a slight decline, as the S&P 500 slipped by 0.4% and Treasury yields rose, with the 10-year yield climbing to 3.675% from 3.615%. However, the report has not dramatically altered expectations for the Federal Reserve’s upcoming decision. CME Fed Fund Futures show a 71% probability of a 25 basis point (bps) rate cut in next week's FOMC meeting, indicating that most investors still expect the Fed to continue its cautious easing approach.

The increase in real earnings for all private workers, up 0.5% in August, contrasts with July’s 0.2% decline, which may provide some relief to consumers facing higher housing costs. Despite the energy index's 0.8% drop, driven by a 0.6% decrease in gasoline prices, the housing and rental costs continue to weigh on the inflation outlook. Markets appear to view the report as relatively neutral, with no major surprises likely to disrupt current Fed policy expectations.

The report did show that the core CPI’s 0.3% MoM gain was slightly higher than July's 0.2% rise, with shelter accounting for over 70% of the 12-month increase in core inflation. Other key categories, such as used cars and medical care, saw declines, while airline fares rose 3.9% after five months of consecutive declines, signaling some volatility in the transportation sector. Overall, the CPI data appears balanced, suggesting that inflation is gradually easing but remains elevated in certain sectors.

In conclusion, while inflation continues to slow, particularly in the headline numbers, the ongoing rise in shelter costs, along with slightly higher-than-expected core inflation, keeps the Fed on track for a 25 bps rate cut next week. The August CPI report seems to be a relative non-event for markets, with investors largely maintaining their expectations for a cautious rate cut in the upcoming FOMC decision.