Key Points:
- This week, the Federal Reserve will review inflation data before making decisions at its upcoming policy meeting on September 18.
- Friday’s jobs report didn’t clarify the size of the expected rate cut, leaving CPI and PPI reports to resolve this.
- The focus has shifted from inflation to concerns over a weakening labor market.
- The CPI report is expected to show a 0.2% increase, but inflation remains above the Fed’s 2% target.
- The Fed will likely start easing with a quarter-point rate cut but may consider larger cuts by year-end.
The Federal Reserve is entering a crucial phase as it reviews inflation data this week before deciding on the widely expected interest rate cut. On Wednesday, the Bureau of Labor Statistics will release the Consumer Price Index (CPI) for August, followed by the Producer Price Index (PPI) on Thursday. These figures will significantly influence the size of the cut at the Fed’s policy meeting on September 18.
While the central bank is almost certain to reduce interest rates, the extent remains unclear, particularly after Friday’s jobs report offered little clarity. Fed officials have shifted focus from inflation alone to growing concerns over a slowing labor market.
Economist Veronica Clark of Citigroup notes that although the labor market has recently been the focal point for the Fed, inflation data such as the CPI remains critical in determining the rate cut size. The August CPI is projected to show a 0.2% increase in both overall and core categories, translating to annual inflation rates of 2.6% and 3.2%, respectively. While this reflects progress, the readings are still far from the Fed’s 2% target.
The Fed’s preferred inflation gauge is the personal consumption expenditures (PCE) price index, which most recently registered a 2.5% inflation rate in July. Nevertheless, officials are also closely monitoring labor market trends, with hiring rates sharply declining since April. Nonfarm payroll gains have dropped from an average of 255,000 to 135,000, and job openings have similarly decreased.
As labor market concerns grow, the likelihood of interest rate cuts has increased. The current federal funds rate sits between 5.25% and 5.50%. Dean Baker, co-founder of the Center for Economic and Policy Research, expects the August CPI report to reflect further progress toward the Fed’s 2% inflation target. He suggests that unless the report presents any surprises, the Fed is likely to proceed with a rate cut, possibly a significant one.
Market expectations align with a modest start to the rate cuts, with a 71% probability of a quarter-point reduction according to CME Group’s FedWatch tool. However, some argue that larger cuts may be necessary. Samuel Tombs of Pantheon Macroeconomics points to the slowdown in hiring and revisions of previous job counts, suggesting that labor market weakness may warrant more aggressive action by the Fed. He predicts a half-point rate cut in November, with another likely in December.
In conclusion, while the Fed is expected to begin its rate-cutting cycle with a cautious quarter-point reduction, upcoming inflation and labor data will shape whether more aggressive cuts are needed in the months ahead.
