Fed Funds Futures Signal 25 Bps Cut Next Week Following Mixed CPI Data
3min read The August Consumer Price Index (CPI) data for the United States has been released, revealing a notable slowdown in headline inflation but showing mixed results for core inflation metrics.
The data, which markets closely watch, offers valuable insights into the inflationary trends affecting the economy and could significantly influence the Federal Reserve's upcoming policy decisions.
Headline CPI Declines, Surprising to the Downside
Headline CPI rose 2.5% year-over-year in August, slightly below the market's expectation of 2.6% and down from the previous month's reading of 2.9%. This marks the smallest 12-month increase since February 2021, indicating that inflationary pressures may be starting to ease. Month-over-month, the CPI was up by 0.2%, aligning with expectations, but on an unrounded basis, the increase was a slightly more modest 0.187%.
This decline in headline inflation is a positive development for consumers and the broader economy, signaling that price growth is moderating. Energy prices played a significant role in this moderation, with the energy index falling by 0.8% month-over-month and showing a 4.0% decline over the past 12 months.
Additionally, food prices rose just 0.1% in August after a 0.2% increase in July, suggesting that inflation in essential categories is cooling.
Core Inflation Remains Sticky
While the headline CPI numbers indicate progress, the story is different for core inflation, which excludes food and energy prices and is a critical measure for the Federal Reserve. Core CPI rose 3.2% year-over-year, matching expectations but still reflecting persistent inflationary pressures. On a monthly basis, core CPI increased by 0.3%, slightly above the expected 0.2%, with an unrounded increase of 0.281%.
The uptick in core inflation is largely driven by shelter costs, which rose by 0.5% in August. The shelter index has been a significant contributor to overall inflation and continues to be a primary concern.
The index for owners' equivalent rent also rose by 0.5%, while the rent index increased by 0.4%. Over the past 12 months, the shelter index has surged by 5.2%, accounting for over 70% of the total 12-month increase in core inflation.
Other core components showed varied results. Lodging away from home surged 1.8% in August after a modest 0.2% increase in July, while airline fares reversed a five-month trend of declines, rising 3.9% in August. Conversely, used cars and trucks, household furnishings, and medical care saw decreases in their respective indices, indicating some relief in these categories.
Real Earnings and Market Implications
An encouraging development from the report is the increase in real weekly earnings, which rose by 0.5% in August compared to a decline of 0.2% in the previous month. Higher real earnings provide a boost to consumers' purchasing power, which could support demand and overall economic growth.
However, the market's reaction to the CPI data has been mixed. Fed Funds Futures now price in an 83% chance of a 25 basis point rate cut at the Federal Open Market Committee (FOMC) meeting next week.
This suggests that market participants expect the Federal Reserve to adopt a more accommodative stance given the easing inflation figures, although the elevated core inflation presents a complicating factor.
Shelter Inflation and the Broader Economic Outlook
The sustained rise in shelter costs is concerning. Shelter inflation is considered "sticky" because it reflects long-term contracts like rent and mortgages that adjust more slowly than other prices. If shelter inflation remains elevated, it could limit the extent to which overall inflation moderates, compelling the Federal Reserve to keep monetary policy tighter for longer.
Notably, the shelter index's year-over-year increase of 5.2% has been a significant driver of core inflation, with its contribution accounting for the majority of the rise in items less food and energy. For the Fed, this poses a challenge; while energy and food prices provide some relief, the structural inflation embedded in shelter costs may require a more cautious approach to rate cuts.
Conclusion: A Complex Inflation Landscape
The August CPI data provides a mixed picture for policymakers and market participants. While headline inflation shows signs of cooling, core inflation remains sticky, particularly due to high shelter costs. As the market digests these mixed signals, the Federal Reserve faces a delicate balancing act in determining the appropriate policy response.
With the next FOMC meeting approaching, this inflation report will likely be a critical input in the decision-making process, influencing whether the Fed opts for a 25 basis point cut or maintains a more hawkish stance to combat underlying inflationary pressures.
Overall, while the data indicates some progress toward the Fed's inflation target, the persistence of core inflation suggests that the path to price stability may still have some hurdles ahead. Market participants should continue to monitor economic data closely, particularly on inflation and labor market conditions, to gauge the future direction of monetary policy and its impact on asset prices.