All eyes will be on the July CPI inflation (Consumer Price Index) report due on Wednesday, August 10, before the market open.
The market hope is that we’ll see the first signs that inflation has peaked after the headline CPI inflation surged at a 9.1% annual rate in June.
That hope hinges on the recent but extended drop in gasoline prices and other energy costs. The hope was left dinged up a bit by Friday’s jobs report for July, which showed the U.S economy added a surprisingly high 528,000 jobs and that the unemployment rate had dropped to a 50-year low of 3.5%.
Why is all this important to the financial markets? Because the markets would love to see signs of an inflation peak that might persuade the Federal Reserve not to raise interest rates at its September 22 meeting by another aggressive 75 basis points.
On Friday stocks dipped after the strong jobs report suggested that the Fed would raise rates by those 75 basis points. The CME FedWatch Tool saw the odds of a 75-basis-point increase rise on Friday to 67.5% from 34% the day before.
I’ve got two questions about the financial market’s reaction to the CPI report.
First, I think there’s a good chance that the headline CPI inflation reading will dip from June’s 9.1%. Gasoline and oil prices are down from a month ago and that should lead to a drop in the headline inflation rate. (The energy index in the CPI showed a 41.6% year-over-year increase in June. It won’t be hard to do better than that in July.) Which could well produce a stock market bounce–if investors pay attention to the headline inflation number even though they know that the Federal Reserve watches the core inflation number.
Second, I think there’s a good chance that core inflation–that is inflation that strips out the effect of volatile energy and food prices–will remain at or near its June levels. Core CPI rose at an annual 5.9% in June. That was a slight dip from a 6% rate in May. I think the odds are that the core rate will remain above 5%. And that is high enough in my mind to convince the Federal Reserve that inflation is still raging and that rates need to go up another 75 basis points in September.
So watch for volatility around the Wednesday release of the CPI data.
Don’t bet that any move higher on “good” headline inflation news will last more than a day or two.
The likelihood is that the core CPI number will be high enough to support the nearly 70% odds of a 75-basis-point increase at the September 22 meeting.
The reaction to this report would likely be stronger if there were an August Fed meeting. September, however, is far enough away so that I’d expect any increase in the odds of a 75-basis-point move would push stock and bond prices down but not in a hurry.
