The CPI night is coming, the market only sees two words: rate cut!

On Wednesday, investors will welcome important data that will impact the Federal Reserve's monetary policy: the US CPI data for July.

Currently, the market expects the year-on-year growth rate of CPI in July to be 3%, unchanged from June; while the month-on-month growth rate is expected to rise from -0.1% last month to 0.2%, as energy prices are expected to rise significantly again.

In terms of core inflation, which excludes volatile costs such as food and gasoline, it is expected that the year-on-year CPI in July will increase by 3.2%, lower than June's 3.3%; the core CPI in July is expected to increase by 0.2% month-on-month, compared to a 0.1% increase in June.

"June's CPI was unexpectedly lower than expected," wrote Michael Gapen, an economist at Bank of America, in a report before the release of the report. "We expect some unexpected reversals in July."

The data for June saw the first negative month-on-month growth rate in core CPI since May 2020, and the slowest year-on-year increase since March 2021.

Gapen stated, "While inflation data for July may not be as low as in June, it is consistent with the previous deflationary trend and should meet the Fed's benchmark for starting rate cuts in September."

Core inflation has remained high, partly due to rising costs of housing and core services such as insurance and healthcare.

After the smallest monthly increase in the Rent and Owners' Equivalent Rent (OER) index since August 2021, housing prices are expected to reverse the slowdown seen in June. Owners' equivalent rent is the hypothetical rent that a homeowner would pay for the same property.

Gapen from Bank of America pointed out that non-housing services saw a slight decline in June, "mainly due to a sharp drop in airfare prices. However, we expect the decline in airfare prices in July to be more moderate."

He warned, "As service sector wage inflation cools, non-housing service inflation rates should decline over time; however, sustained deflation is unlikely for a period of time."

How many basis points will the Fed cut rates by?

Before Wednesday, the US Producer Price Index (PPI) for July came in lower than expected, sparking investor expectations of a Fed rate cut and further emphasizing the reasons for a Fed rate cut.

The PPI index is a key indicator of wholesale inflation and is often seen as a signal for consumer price trends. It rose by only 0.1% month-on-month last month, compared to 0.2% in June, lower than economists' expectations. The index rose by 2.2% year-on-year, slightly above the Fed's 2% inflation target.

John Stoltzfus, Chief Investment Strategist at Oppenheimer, stated on Tuesday, "This is good news for the stock market. It dispels some of the pessimism that has been hanging over the market this month. We can't help but think that this gives the Fed an opportunity to start cutting rates." The CPI has been consistently higher than the Federal Reserve's 2% target, but recent economic data, including the July non-farm payroll report that triggered market sell-offs, has fueled market expectations for the Fed to cut interest rates as soon as possible.

It is worth noting that the Fed's preferred inflation measure, the so-called core PCE price index, showed that inflation in June remained unchanged compared to the previous month, reaching the slowest pace in over three years on a year-on-year basis.

Currently, the market expects the probability of a rate cut by the Fed before the end of its September meeting to be close to 100%. However, according to the CME Group's FedWatch tool, the probability of a 50 basis point or 25 basis point rate cut by the Fed in September is now evenly split at 50%.