After last week's surprising U.S. labor market data disrupted expectations of aggressive rate cuts, markets are awaiting today's inflation data for further clues.
In the year's third quarter, U.S. inflation showed signs of easing more quickly, while labor market data revealed a much sharper cooling than anticipated. This prompted the Federal Reserve to shift its focus towards labor market risks, leading to a larger-than-expected half-point rate cut at the September meeting. Fed Chair Jerome Powell described this move as a "recalibration," framing it as a preemptive measure against further labor market softening while inflation neared its target.
Fed officials' determination not to allow further cooling of the labor market has fueled expectations of another half-point rate cut in November. However, last week's data revealed that the U.S. labor market remains strong, pushing back expectations for aggressive rate cuts.
The resilient labor market allows policymakers to lower interest rates slower. However, the current question is whether inflation will support quarter-point cuts at this year's two remaining meetings. As a result, markets will be closely watching today's inflation reading for signs that price pressures in the U.S. are under control.
Inflation Eases, Will Fed Stay the Course?
According to Bloomberg’s median forecasts among economists, the Consumer Price Index (CPI) rose by 0.1% in September, following a 0.2% increase in the previous month. On an annual basis, the rise is projected to slow to 2.3%, marking the slowest pace since early 2021.
The core measure, which excludes food and energy, is expected to slow to 0.2% after a 0.3% increase in the previous month. The annual core reading, on the other hand, is expected to remain unchanged at 3.2% for the third consecutive month.
If the figures agree with consensus, they are unlikely to significantly impact the Fed’s policy decision in November. However, some market participants worry that the Fed may pause at the next meeting if inflation rises. Ultimately, as long as employment remains strong, the Fed’s gradual rate cuts will depend on inflation continuing to fall towards the target rate.
Inflation Holds Key as Fed Weighs Future Rate Cuts
According to futures market data, an 84.8% probability of a quarter-point cut at the next meeting is priced in, while bets that the Fed will not act stand at 15.2%, a small minority.
The minutes of the September meeting, released earlier in the day, showed that most officials supported a half-point cut, though some preferred a smaller move. In the final stretch, comments from Fed officials highlight that the half-point cut is considered prudent, but future steps should be taken at a more gradual pace.
Meanwhile, Federal Reserve Governor Adriana Kugler emphasized that the Fed must stay focused on bringing inflation back to the target rate, stressing that if progress stalls, rate cuts may need to slow. Following her, San Francisco Fed President Mary Daly stated that her outlook might include one or two more cuts this year. This comment indicates that officials have not ruled out the possibility of a pause at one of the two upcoming meetings.
Fed officials now see risks to the labor market and inflation as being more equally balanced, meaning that inflation data will play a key role in upcoming policy decisions if the labor market remains strong.
Economists highlight wage growth, the main driver of consumer spending, as the most significant upward risk to inflation. As long as wage growth remains robust, it poses a clear inflationary risk. In addition, economists note that the impact of nearly doubling transportation costs earlier this year, which lag by at least six months in the index, may begin to show gradually. This could put pressure on goods prices, which have recently declined.
On the other hand, even if inflation shows a modest increase, it will need to be debated whether it is significant enough to prompt the Fed to pause. However, a potential rise will likely contribute to the market reaction following the payroll report.