The July personal consumption expenditures inflation report on Friday is likely to reassure investors that an initial interest-rate cut by the Federal Reserve is in store for next month - but don't expect the stock market to celebrate, according to market experts.
The Fed's preferred inflation gauge is expected to show that U.S. consumer prices ticked up slightly in July, complicating the timetable for the central bank to cut policy rates next month. Investors worry that the latest report may not provide enough clarity to the financial markets on how fast and how far the Fed will ease.
Economists polled by the Wall Street Journal expect the headline PCE price index to remain steady at 2.5% year over year in July, while the core PCE, a more closely watched measure that strips out volatile food and energy costs, is forecast to drift higher to 2.7%, from 2.6% in the previous month.
"The September cut is firm enough that the PCE trend is not going to change that," said Burns McKinney, managing director and portfolio manager at NFJ Investment Group. "The Fed has already made up their mind that they've already telegraphed very firmly and very dovishly that they are absolutely going to start the rate-cutting cycle in September."
Fed Chair Jerome Powell last week gave his strongest signal yet, saying that "the time has come" for monetary easing as economic data over the past few months have convinced policy makers that inflation is firmly on the path back to the central bank's 2% target.
Will July PCE report support a disinflation scenario?
Some investors think the upcoming July inflation data, if in line with expectations, would make it hard to justify the Fed's "sudden new embrace" of interest-rate cuts. "A single cut in September, okay. But to forecast multiple cuts off this [PCE] data seems unjustified," said Barbara Rockefeller, president and chief economist at Rockefeller Treasury Services.
But others say that the disinflation momentum could still be sustained despite the anticipated modest uptick in the core PCE. "Powell has always warned against getting too caught up in a single data point, and if you look at the trend, regardless of what [the data release] does, the [disinflation] trend has been pretty well locked in," McKinney told MarketWatch via phone on Tuesday.
Gregory Daco, chief economist at EY, said economic fundamentals are pointing to sustainable disinflation as increased pricing sensitivity, easing shelter cost inflation, moderating wage growth and strong productivity growth should all continue to push inflation toward the Fed's 2% target, notwithstanding the lingering risk of energy price shocks (CL.1) (CL00).
His team anticipates the core PCE to slow to around 2.5% year over year by the end of 2024, Daco wrote in emailed commentary on Wednesday.
Investors disagree on the Fed's path forward
Another key question for financial markets is whether the Fed will begin with a 25- or 50-basis-point rate cut in September, but Friday's PCE report will do little to resolve the conundrum on the path forward, the analysts said.
Markets may be running ahead of themselves by betting on aggressive rate cuts this year. Fed-funds futures traders on Wednesday were pricing in a 36.5% chance of a half-point rate reduction in September, up from 24% last week. Meanwhile, the likelihood of a quarter-point reduction fell to 63.5% from over 75% a week ago, according to the CME FedWatch Tool.
The PCE report no longer has the weighting on the central bank's decisions that it had before, said Matt Lloyd, chief investment strategist at Advisors Asset Management. "Now the labor market is the one that will probably skew whether it's 25- or 50-basis-point cuts in the following meeting," he said.
In particular, August employment data from the Labor Department due on Sept. 6 could be decisive if it matches July's slowdown in hiring and a 4.3% unemployment rate.
How might markets react?
Lloyd said financial markets may not react too much to the PCE data on Friday ahead of the Labor Day weekend, as investors may decide to go "risk neutral" heading into the unofficial end of summer. However, stocks will have a more "heightened" focus on next week's August jobs report.
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But Lloyd didn't rule out the chance of volatility surging in the financial markets on Friday, as trading volume is expected to remain light, which may "skew the returns in the Treasuries and equities," he told MarketWatch in an interview.
Trading volumes have been thin this week. Tuesday's session saw the lowest stock-market volume since Aug. 28, 2023, according to Dow Jones Market Data.
U.S. stocks were rising on Thursday after the latest batch of economic data boosted investors' confidence that the economy was headed for a soft landing. The Nasdaq Composite COMP was up 0.9%, while the S&P 500 SPX was popping 0.6% and the Dow Jones Industrial Average DJIA was gaining 0.5%, according to FactSet data.
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