What will happen if CPI exceeds expectations?

Wholesale inflation in the United States fell as expected in July, slowing down after an unexpected surge last month. This sets the market's expectations and sentiment for the CPI data to be released on Wednesday night at 8:30.

According to data released by the U.S. Bureau of Labor Statistics on Tuesday, the Producer Price Index (PPI), which measures the average price change for producers and manufacturers, recorded a year-on-year increase of 2.2%, significantly lower than the 2.7% in June, with a month-on-month increase of 0.1%, also lower than the 0.2% in June. PPI reflects the inflation trend upstream of consumers and can serve as a potential indicator for retail inflation in the coming months, hence investors are pleased with the slowdown in PPI.

Chris Larkin, Managing Director of Trading and Investing at E*Trade, commented, "The search for a stable market has received more evidence of cooling inflation." He said, PPI is just an appetizer, with CPI on Wednesday being the main course, and given that the stock market is attempting to rebound from its largest pullback this year, data below expectations will be well received.

Everyone is Watching CPI!

This week's inflation data, especially Wednesday's CPI, will be closely watched as the unexpected softness in the employment report at the beginning of the month has left the market in turmoil. Economists expect CPI to show continued weakening of inflation, but progress may not be as fast as PPI.

Lydia Boussour, Senior Economist at EY-Parthenon, stated in an interview on Monday that she expects July's CPI to show "the ongoing process of inflation easing and remaining on track."

According to FactSet estimates, CPI is expected to rise by 0.2% from June, possibly driven by an increase in natural gas prices, while the year-on-year increase is expected to remain stable at 3%. Core CPI is also expected to rise by 0.2%, but the annual rate is expected to slow to 3.2%.

Boussour noted that July's CPI data may exceed expectations, reflecting that natural gas prices are no longer dragging down the data as they did in May and June. However, she pointed out that food prices should remain fairly moderate, helping to offset the rise in energy prices.

The most noteworthy aspect is housing inflation. Housing inflation has long been a major driver of high inflation. However, housing inflation has slowed in recent months, and CPI will gradually reflect the slowdown in rent increases in real life. In June, the housing index rose by only 0.2%, the slowest monthly increase in three years. Looking at the year-on-year comparison, prices related to housing increased by 5.2%, the lowest increase in two years.

Boussour said, "We need to see if the trend can be confirmed, indicating that the strong pace we saw at the beginning of the year has slowed down, or if this is just a one-time occurrence." "We expect the latest data to maintain a soft momentum."

Considering the trajectory of declining inflation and the view that the economy is gradually slowing down, Boussour expects the Federal Reserve to cut interest rates by 3 percentage points before the end of this year and by another 1.25 percentage points in 2025

What to Do If CPI Overheats?

Andy Schneider, a senior US economist at BNP Paribas, said that one month cannot indicate a trend, but if the CPI in July exceeds expectations, it may further unsettle already nervous investors and trigger a "rapid market reaction" to stagflation concerns. Stagflation refers to the simultaneous occurrence of economic recession and rising inflation, both of which are difficult problems and a vicious cycle that is hard to break.

However, he stated that these concerns are unfounded, and the key to determining whether there is stagflation or not is to look at whether inflation expectations are relatively high.

Schneider pointed out that although the current unemployment rate of 4.3% has recently risen, it is still far below the average level of the past 50 years. Crucially, since reaching a high point not seen in 40 years in June 2022, inflation has also significantly cooled. In addition, new survey data released by the New York Fed this week shows that consumers' three-year inflation expectations for July have dropped to 2.3%, the lowest level since the survey began in 2013. One-year and five-year inflation expectations remain stable at 3% and 2.8%, respectively.

Schneider also mentioned that even if inflation accelerates, it may not necessarily change the Fed's consideration of easing monetary policy. The market generally expects the Fed to initiate its first rate cut at the September meeting