The August Consumer Price Index (CPI) data, set to be released tomorrow, will provide Federal Reserve (Fed) policymakers with one final data point before the September 17-18 policy meeting.
The non-farm payroll report was not sharp enough to settle the debate over the extent of the Fed’s rate cuts, so markets shifted their focus to the inflation data.
In his speech at the Jackson Hole symposium on August 23, Fed Chair Jerome Powell expressed growing confidence that inflation would reach the target rate, signalling that the Fed's focus shifted from inflation to labour market risks.
Since then, many Fed officials have prioritized labor market risks in their statements, while some continued to issue cautious remarks, emphasizing that inflation risks have not fully subsided.
Following the payroll report, expectations for a rate cut at the September meeting have shifted towards 25 basis points. However, markets are still betting on more than 100 basis points in total rate cuts by the Fed this year. In this context, markets will closely assess whether the upcoming inflation data will persuade the Fed to consider a 50 basis point cut before the meeting.
August CPI Expected to Decline as Core Inflation Stays Firm
In July, the annual CPI rose by 2.9%, falling below 3% for the first time since March 2021. Besides, the core index, which excludes food and energy prices, recorded a 3.2% increase, marking the smallest rise in the past 12 months. The standout component driving the core inflation increase was the shelter index, which accounted for more than 70% of the total rise.
Economists surveyed by Bloomberg expect the headline CPI for August to remain unchanged every month, with a 0.2% increase, while predicting that annual inflation will fall to 2.6%. On the other hand, core inflation is expected to remain elevated with a 3.2% increase.
These figures reflect expectations that pressures on goods prices in the U.S. will ease while the rigidity of service prices will continue.
Cooling Labor Market, Persistent Consumer Spending: A Dilemma for Inflation
U.S. household consumption spending is critical to the trajectory of inflation. This year, U.S. consumers have surprised markets by continuing to spend despite dwindling savings and a cooling labor market.
Labor market data shows that permanent layoffs have not significantly increased, but U.S. employers have put new hiring on hold. However, the continued rise in wages is supporting consumption, remaining an inflationary pressure. According to data released last Friday, average hourly earnings grew by 3.8% year-on-year, exceeding expectations and rising from the previous 3.6%.
On the other hand, U.S. household personal savings rates have fallen to their lowest levels since the mid-2000s, while debt levels are rising. According to data released by the Fed on Tuesday, total credit debt increased by $25.5 billion in July, marking the most significant rise since November 2022. Surges in non-revolving debt and credit card balances drove this increase.
Moreover, Fed data reveals that home equity loans, which were unpopular after the 2008 crisis, have risen since the beginning of the year. By the end of August, the loan increase had reached 2% compared to the previous year. Economists point out that high levels of housing wealth could make home equity loans attractive to U.S. consumers.
Consequently, while the cooling labor market and dwindling savings are making it harder for U.S. households to continue spending, they tend to maintain their consumption habits by relying on debt.
High consumption levels are weakening inflation's decline. Therefore, it is hard to expect a significant enough drop in August inflation to convince the Fed to implement a 50 basis point rate cut next week.
As the Fed lowers interest rates, borrowing costs for U.S. consumers will fall, potentially encouraging more debt. This situation could prompt the Fed to gradually monitor future data instead of opting for front-loaded rate cuts.