Probability of Fed Rate Hike in September Drops Again? Economists Expect Core CPI to Hit Five-Year Low

The unexpectedly weak July non-farm payrolls report released this Friday has cooled market expectations for a Federal Reserve rate hike in September, with recent inflation data potentially becoming key to determining the policy direction. Bloomberg economists expect US core CPI growth to slow to a five-year low, further weakening the rationale for hawkish demands within the Federal Reserve to continue tightening policy.

Bloomberg economists, including Anna Wong, stated in their latest weekly outlook report that while the July employment report dampened market bets on a September rate hike, the option of a hike has not been completely removed from discussion. Currently, there is a clear divergence between views within the Federal Reserve and those in the market: one camp believes the central bank needs to reaffirm its determination to fight inflation through rate hikes, especially against the backdrop of Chair Kevin Warsh needing to uphold anti-inflation credibility; the other camp argues that price pressures are easing, and maintaining the current policy path is the correct choice for the Federal Reserve.

The Bloomberg economics team expects that the upcoming July CPI and PPI data will further support the latter view, and predicts that the Federal Reserve will most likely keep interest rates unchanged at its September meeting.

Core CPI May Post Lowest Year-on-Year Gain Since March 2021

Bloomberg believes that the July CPI report, to be released next Wednesday, will become the focus of market attention.

The team expects the overall July CPI to rise 2.4% year-on-year, with the year-on-year gain further slowing to 2.2%-2.3% in the following two months. They pointed out that, historically, this usually corresponds to core CPI slowing to 2%, which would be the lowest gain since March 2021.

The team noted that with core PCE inflation approaching the Federal Reserve's 2% target, the current disinflation trend may be moving closer to the policy target again.

If these predictions materialize, they will challenge the view recently emphasized by some Federal Reserve hawks that US inflation remains persistently above the 2% target, thus requiring the central bank to take tougher measures.

The team also expects month-on-month CPI growth in July to be flat, while core CPI will rise 0.1% month-on-month in July.

Divergence in Inflation Indicators Keeps Federal Reserve Cautious

However, the Bloomberg economics team also warned that the Federal Reserve cannot ignore the significant divergence among different inflation indicators.

Currently, core CPI is expected to continue cooling; however, core PCE inflation remains above 3%.

Bloomberg believes that such a significant deviation between core CPI and core PCE is an abnormal situation that cannot be simply ignored.

This instead supports the view previously proposed by Federal Reserve Chair Warsh that the Federal Reserve needs to observe a broader range of economic indicators rather than relying on a single inflation indicator to determine policy direction.

Therefore, even if July CPI cools further, hawks within the Federal Reserve may still believe that more evidence is needed to confirm that inflation is continuing to fall.

Cooling Housing Market Also Reduces Risk of Inflation Rebounding

In addition to inflation data, the Bloomberg economics team is also monitoring trends in the US housing market.

The report pointed out that elevated mortgage rates continue to suppress housing activity.

Pending home sales weakened significantly in June, implying that existing home transactions may remain sluggish in July.

Bloomberg expects the annualized total of existing home sales for July, to be released next Tuesday, to be approximately 4.01 million units, a 2% month-on-month decrease.

Economists believe that weak demand and improved supply are driving a rebalancing of the housing market, helping to alleviate future housing price pressures rather than creating new inflation risks.

Since housing costs have long been a significant component of US inflation, a cooling real estate market may further drive down inflation.

Bloomberg Expects Federal Reserve to Hold Steady in September

Combining signals from employment, inflation, and the housing market, the Bloomberg economics team expects the Federal Reserve to keep interest rates unchanged at the September FOMC meeting.

The team believes that the upcoming CPI and PPI data may further support a "wait-and-see" policy stance.

In addition to inflation data, the market will also focus on the following US economic data to be released in the coming week:

• Initial jobless claims for the week ended August 8, to be released next Thursday;
• July PPI, to be released next Thursday;
• July retail sales, to be released next Friday;
• Preliminary University of Michigan Consumer Sentiment Index for August, to be released next Friday.

These data will help the Federal Reserve assess whether economic momentum is weakening further.

September Policy Focus Shifts to Inflation as Federal Reserve Awaits More Evidence

Following the release of the July non-farm payrolls report, the core question for the Federal Reserve's September meeting has shifted from "whether a rate hike is needed" to "whether a rate hike is still necessary."

A cooling labor market and slowing wage growth provide more reasons to keep interest rates unchanged; however, with core PCE still above 3% and concerns among some officials regarding inflation credibility, the possibility of a rate hike has not completely disappeared.

As pointed out by the Bloomberg economics team, if CPI continues to decline in the future, the rationale for the Federal Reserve to maintain its current policy path will be further strengthened; but if inflation rebounds, the hawkish camp may regain the initiative.

Therefore, before the September FOMC meeting, the market's focus will shift from employment to inflation: whether July CPI can prove that US price pressures are continuing to ease will be the key evidence determining the Federal Reserve's next move.

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