The U.S. August CPI is coming in hot, two major rate-cut camps are facing a "decisive battle"!

The analysis believes that if the CPI meets expectations, it will reinforce the expectation of a 25 basis point rate cut. However, if inflation unexpectedly decelerates, it may push the Federal Reserve towards a 50 basis point rate cut, especially if the slowdown in inflation is concentrated in the service sector

How many basis points did the Fed cut interest rates in September, and the non-farm data did not "settle the matter" once and for all. The market is now shifting its focus to tonight's CPI. Will the "25 or 50 basis points rate cut" camps face a "decisive battle"?

At 20:30 Beijing time on Wednesday, the US Bureau of Labor Statistics will release the August CPI data. Currently, Wall Street generally expects:

The month-on-month increase in both US CPI and core CPI in August is expected to be 0.2%, the same as the previous month.
In terms of year-on-year growth, the market expects the August CPI to increase by 2.5%, slowing down from the previous 2.9%, while the core CPI remains unchanged from the previous 3.2%, only a third of what it was two years ago.

Regarding the impact of the August CPI on the Fed's decision, Fuguo Bank stated that the FOMC will hold a monetary policy meeting on September 18, and a rate cut is almost a certainty. With the August non-farm report in a clear "gray area" of weakness and strength, the upcoming CPI data may become the decisive factor in deciding whether to cut rates by 25 or 50 basis points.

According to the CME FedWatch Tool, the probability of a 25 basis points rate cut by the Fed in September is 67%, while the probability of a 50 basis points rate cut is 33%. Analysis believes that meeting the expected CPI will solidify the expectation of a 25 basis points rate cut, while a higher-than-expected cooling off could increase the possibility of a 50 basis points rate cut. The weaker the August CPI data, the more favorable it is for the market, and the greater the possibility of a 50 basis points rate cut.

Rents are expected to return to a downward trend, while airfare and used car prices may rise.

Looking at the sub-item data, analysts believe that after rising in July due to abnormal conditions in the western region, rent inflation in August is expected to be lower than in July. In the coming months, the main reasons for the softening inflation are expected to be the rise in airfare and used car prices, with a slowdown in car insurance inflation, while clothing prices remain the biggest variable.

First, looking at rents, Nomura economist Aichi Amemiya stated that the All Tenants Rent Register (ATRR) from the US Bureau of Labor Statistics is the most reliable leading indicator, indicating that official rent inflation is declining. In addition, the supply of rental apartments remains high, so the potential trend of rent inflation is unlikely to accelerate again in the near term. If rent inflation decreases, this will help offset the rebound in other service categories (such as healthcare and airfare) after the unusual decline in July.

Goldman Sachs believes that after a significant increase in July, housing inflation is expected to ease, with owner's equivalent rent (OER) rising by 0.33% and primary rent rising by 0.29%. However, looking ahead, the growth of single-family home rents is slightly accelerating, which may cause OER to outpace rent in the CPI. It is expected that the overall housing inflation rate will run at a rate of around 0.3% month-on-month by December 2024.

It is worth mentioning that Goldman Sachs pointed out that the forecast for core CPI in August is higher than the average growth rate of 0.13% over the past three months. The recent softening in data is mainly driven by lower airfare prices (average decrease of 3.4%) and used car prices (average decrease of 1.1%), but due to seasonal factors such as the summer travel season, airfare prices are expected to rise in August (+1.5%).

Rents Expected to Return to Downward Trend, Airfare and Used Car Prices May Rise

From a sub-item perspective, analysts believe that after rising in July due to abnormal conditions in the western region, rent inflation in August is expected to be lower than in July. In the coming months, the main reasons for the softening inflation are expected to be the rise in airfare and used car prices, with a slowdown in car insurance inflation, while clothing prices remain the biggest variable.

Secondly, the inflation of car insurance is expected to slow down. Over the past two years, car insurance inflation has been a major driver of inflation in the U.S. service sector. However, there are signs that insurance providers may slow down the rate of price increases in the coming months. Morgan Stanley analysis indicates that insurance rate applications in July seem to have started to decelerate, and this trend is expected to continue, with a more noticeable slowdown in car insurance CPI by the end of the year.

In addition, clothing prices may become an important variable affecting the August CPI. Clothing prices saw the largest drop so far this year in July, and analysts have differing opinions on whether prices will drop again in August, indicating that any significant fluctuations could impact the overall inflation reading.

The "decisive battle" of whether the Fed will cut rates by 25 or 50 basis points in September

Non-farm data did not provide a definitive answer, and the U.S. CPI may set the tone for a rate cut in September.

Analysts generally believe that an as-expected CPI will solidify expectations of a 25 basis point cut. Oscar Munoz, chief strategist at TD Securities, believes that the rate cut will start at 25 basis points next week. The short-term policy rate of the Federal Reserve is close to the highest level in twenty years, raising borrowing costs for households, businesses, and even the U.S. government. People have been hoping that raising rates will help curb inflation without derailing the economy.

Regarding the possibility of a 50 basis point cut, Marc Chandler, strategist at Bannockburn Global Forex, stated:

If the non-farm report did not pave the way for a 50 basis point cut by the Federal Reserve, then it seems unlikely for the CPI to do so as well. The current expectations are not enough to push the Federal Reserve to cut rates by 50 basis points. However, if an unexpected slowdown occurs, with core CPI at -0.3% to -0.5%, it may push us towards the edge of 50 basis points, especially if inflation decelerates in the service sector of the CPI.

However, economists Veronica Clark and Andrew Hollenhorst from Citigroup stated in a data preview on September 9:

In terms of relevance to Federal Reserve policy decisions, inflation data is quickly giving way to labor market data, but with no definitive conclusion on the August employment report, August CPI data may have an impact.
Given the increasing downside risks to the labor market and economic activity, weak CPI data and a lower threshold for a larger rate cut may be likely.

How will the market react?

So, how much of a splash will tonight's CPI announcement make in the market?

Goldman Sachs believes that soft data close to expectations may be the best outcome, allowing for some event risk transfer and a slight decrease in stock volatility in the short term. Overheated or overly cold data may bring more uncertainty to the Federal Reserve's rate cut path and the level of U.S. economic growth.

According to Goldman Sachs traders' predictions, if core CPI rises by 0.2%-0.25% month-on-month, meeting or slightly exceeding market expectations, the S&P 500 index may fluctuate up and down by 0.5%. However, if it slightly falls below market expectations, the S&P 500 index is expected to achieve a stronger rise