Markets are relatively calm after rebounding from the chaos of “Manic Monday” last week. That was a perfect storm of several drivers reacting together in summer markets. Investors face the first big test of this stabilisation with the next key piece of US data on Wednesday, when we get the first of two US inflation reports before the FOMC September 18^th decision. There will then be one more reading of the Fed’s preferred PCE measure at the end of this month.

The prior CPI report put disinflation firmly back on track and drew the Fed another step closer to cutting interest rates next month. It was the second straight month of benign price readings after surging in the first quarter of 2024. The data also showed a measure of underlying inflation posting the smallest increase since August 2021 on a monthly basis,

Expectations for July prices

Consensus sees the monthly headline printing at 0.2% in July, up from the first negative print in four years in June, amid cheaper gasoline and moderating rents.  That works out to a July print of 3.0% for the annual headline figure, matching the low in June last year. The core figures are predicted to rise one-tenth to 0.2% m/m and the annual reading one-tenth lower than in June, at 3.2%.

Some economists are pointing to upside risks in the numbers due to the pickup in core services inflation and energy prices. The core services ex-rent and owners’ equivalent rent (OER) edged down in June on a decline in airfares. But the decline in airfares is likely to be much more moderate this time. That said, housing service influences are forecast to continue gradually easing in the months ahead.

Market reaction

Money markets were upended last Monday and at one point started pricing in an intra-meeting rate cut by the FOMC. That debate has cooled somewhat although there were still around 100 bps of rate reductions priced in for this year with only three Fed meetings remaining, at the start of this week. Should the July CPI report print in line with expectations, policymakers are likely to start their cutting cycle in September, though the bar for a larger upfront 50 bps in rate cuts next month does seem rather unlikely. Markets are currently near a 50:50 bet on a 25 bps or 50 bps rate cut next month, so this could be pared back and give a mild short-term lift to USD.

Any signs of a serious pick-up in inflationary pressures could spook markets which are highly sensitive to economic data. A hot print could mean the markets are forced to take down the probability of a US recession and sharply rein in the amount of expected rate cuts from the Fed, which would boost the dollar. However, markets could quickly move from recession threats to stagflation fears if CPI turns out to be very hot. The flip side and a soft CPI report would likely see the dollar trade lower and the stock rebound continue. Gold could push up to its record highs.

We note that consumer data also remains a key focus for markets to understand how fast the economy can slow. This makes Thursday’s retail sales potentially important, along with consumer corporate earnings from the likes of Home Depot on Tuesday and Walmart who release on Thursday.