‘Broadly speaking, the weaker this number, the better for markets’: strategist
The August consumer-price index is due out Wednesday and could help steer the Federal Reserve’s first interest-rate cut in four years.
Weakness in the labor market has Wall Street on edge ahead of Wednesday’s inflation update, which should provide more clues as to how big a pair of scissors the Federal Reserve might take to interest rates next week.
After a blip earlier this year, inflation readings lately have been easing in the right direction, allowing the Federal Reserve to focus on the health of the labor market and opening the door to rate cuts for the first time in four years.
Fed Chair Jerome Powell’s August speech at the Jackson Hole Economic Symposium set the table for a likely rate cut at the conclusion of the central bank’s Sept. 17-18 policy meeting. But how much the Fed will — or should — cut rates by remains an open question on Wall Street.
“My view is they start with 25 basis points in rate reductions next week,” said Oscar Munoz, chief U.S. macro strategist at TD Securities. “But I wouldn’t push back too hard on 50.”
The Fed’s short-term policy rate has been sitting near its highest level in two decades, raising borrowing costs for families, businesses and even the U.S. government. The hope has been that elevated rates would help tame inflation without derailing the economy.
Traders on Tuesday were putting the odds of an ordinary rate cut of 25 basis points at next week’s meeting at about 70%, according to the CME’s FedWatch Tool. The odds of a cut double that size were closer to 30%.
CPI in focus
“Wednesday’s CPI could be the deciding factor in whether the Fed decides to cut 50 bps [next] week or 25 bps,” said Tom Essaye, founder of Sevens Report Research, in a Monday note. “Broadly speaking, the weaker this number, the better for markets and the greater the chance the Fed does cut 50 bps. And regardless of recent growth data, the market will generally welcome the bigger expected rate cut.”
The August consumer-price index is expected to rise 0.2%, bringing the year-over-year rate of inflation down to 2.6% from 2.9% in July, according to a Wall Street Journal survey of economists. The more closely watched core rate, which excludes volatile food and energy prices, is also seen moving up 0.2%, which would leave the year-over-year rate unchanged at 3.2%.
“I don’t know why they wouldn’t go 50,” said Chris Diaz, portfolio manager and co-head of global taxable fixed income at Brown Advisory, in an interview with MarketWatch. “But that’s the big debate in the market right now.”
Diaz said Wednesday’s August CPI clearly looks to be less important than inflation readings have been in recent months. But he’ll still be watching the shelter and “supercore” components of the reading for clues as to what the Fed might do with rates.
Munoz at TD Securities said that while inflation still isn’t back to the Fed’s 2% yearly target, all the August CPI reading needs to do is to avoid extremes to keep market volatility in check.
“The risk is we’ve rallied quite a bit,” Munoz said of stocks in anticipation of significant rate cuts from the Fed this year and into 2025.
Despite a weakening U.S. economy and a rough start to September for markets, the S&P 500 was up 15.2% on the year as of Tuesday’s close, while the Dow Jones Industrial Average was 8.1% higher and the Nasdaq Composite was up 13.4%, according to FactSet.
Diaz said he supports a larger rate cut because of his concerns about the labor market. While the economy has continued adding jobs each month, there have been surprising downward revisions to earlier payroll estimates, as well as a concentration of new jobs in the government, healthcare and education sectors — all areas that tend to be noncyclical and less sensitive to the strength of the economy.
“I do think there is reason to be really concerned about the jobs market,” Diaz said.
Stocks and jobs
Stocks have been volatile since early August, after a surprisingly weak July jobs report put investors on alert about a slowing labor market. It also sparked questions about whether the Fed had waited too long to pivot to rate cuts.
Powell’s Jackson Hole speech in late August was notable for putting inflation concerns on the back burner, while signaling the central bank’s limited tolerance for further weakening in the jobs market.
“Powell was very clear in his Jackson Hole remarks that the emphasis has shifted and the labor market has become more important than inflation,” said Marc Chandler, chief market strategist at Bannockburn Global Forex in New York.
If August’s nonfarm-payrolls report released on Sept. 6 didn’t clear a path to a 50-basis-point Fed rate cut, “it seems unlikely the CPI data will,” Chandler said by phone.
To that end, an as-expected monthly core rate of 0.2% for August wouldn’t be enough to move the needle, he said. But an unanticipated deceleration that produces a reading of minus 0.3% to minus 0.5% for the month “might push us over the edge” toward a 50-basis-point cut, particularly if it is concentrated in the services part of the CPI, the strategist added.
Looking beyond September, fed-funds futures on Tuesday implied that borrowing costs will likely drop by a full percentage point or more through December, and by 2.5% through the end of 2025.
Diaz at Brown Advisory said that pricing appears to reflect a market that’s “caught somewhere between a soft landing and a recession,” in terms of expectations for the economy. “We don’t necessarily think that’s an excessive amount over the longer term,” he said, adding investors shouldn’t rule out the potential for even more rate cuts.
On the other hand, Chandler at Bannockburn thinks the current odds of rate cuts reflect traders’ tendencies to “push things to the extreme.” He added, however, that “there are concerns that we might be at some kind of inflection point in the labor market” that could lead to a sharp contraction in jobs.
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