CPI is no longer "blowing up"? The new normal after the ebb of inflation may have arrived

The inflation level in the United States has soared to historic highs and is gradually falling back. In the past, whenever CPI data was released, the market always experienced significant fluctuations. However, as prices cool down, the market's reaction to CPI has also weakened.

Unfortunately, the "magic" that once caused intense market volatility has disappeared. Now, non-farm payroll data is the focus of the market, as the Federal Reserve has shifted its focus to its employment target. Nevertheless, CPI data remains an important market driver, especially the most important data this week.

Currently, the market generally expects a 0.2% month-on-month increase in CPI and a 2.6% year-on-year increase, the lowest year-on-year level since 2021. In fact, since CPI returned to the "2-handle" in July, any data lower than the 2.9% from the previous month will be the lowest reading since 2021.

This also reminds us that inflation is gradually returning to the Federal Reserve's target level. The recent decline in oil prices has had a certain dampening effect on inflation. Oil prices have dropped significantly in the past week, with the current price of $65.80 per barrel down more than 25% from the same period last year. This downward trend is expected to have a positive impact on next month's inflation report. Even if this month's CPI data unexpectedly increases by 0.1 or 0.2 percentage points, the market may not overreact.

Of greater concern is the core CPI data, which excludes the impact of food and energy. The market expects core CPI to increase by 0.2% month-on-month and 3.2% year-on-year. Part of the reason is that changes in housing prices and rents take time to be fully reflected in the data. In addition, the Federal Reserve is also monitoring "super core" inflation, which excludes housing-related service CPI. This index increased by 4.5% year-on-year last month, reminding us that the decline in commodity prices has largely supported the cooling of inflation data, partly due to the slow transmission of insurance rates.

From market expectations, forecasts for core CPI are relatively balanced, with economists' expectations of upside or downside movements being roughly equal. However, in terms of overall CPI year-on-year data, the market tends to expect a downward deviation.

Why is this report potentially more important than some recent inflation reports? The key lies in the Federal Reserve FOMC (Federal Open Market Committee) meeting on September 18. The market has not yet determined whether Powell will choose to cut rates by 50 basis points or 25 basis points. Currently, the market expects a 33% probability of a 50 basis point rate cut, but if both core and overall inflation data in this report show a slight decline, even if not significant, the probability may rise to 40%.

Many economists unanimously believe that the Federal Reserve should cut rates by 50 basis points, but they may not do so. Analysts believe that Powell and other FOMC members are strongly inclined to take action early to address signs of economic weakness mentioned in the Fed's Beige Book In addition, the bond market is strongly suggesting that inflation is no longer a concern, as the yield on the US 5-year Treasury bond has dropped to its lowest level since 2023. The five-year breakeven inflation rate has also fallen to 1.88%, the lowest level since December 2020, indicating that the Federal Reserve may face the risk of inflation falling below the 2% target level.

How will the foreign exchange market react to tonight's CPI data? Overall, Forexlive analyst Adam Button believes that the US dollar faces downside risks, while risk assets may rise due to this inflation data. If inflation data unexpectedly rises, the market should be able to digest it easily as the pressure from oil prices and raw materials is becoming evident. At the same time, if the data is below expectations, the Federal Reserve may achieve its 2% inflation target this year. Although some base effects at the end of the year may bring some pressure, the overall downward trend in inflation will further prove that inflation is "fading away."