Fed cut likely as inflation hits two-year lows

ECB rate cut

The ECB met last Thursday and unanimously decided to cut their deposit rate by 25 basis points to 3.50%. The Central Bank provided little indication as to whether they will continue to cut rates at their next meeting, emphasizing that they will look to future data releases to inform future monetary policy decisions. At of the end of last Friday, the market was still pricing in seven rate cuts over the next seven months. The ECB also cut their refinancing rate by 60 basis points to 3.65%, hitting a target corridor of 15 basis points between the refinancing and deposit rate. The Central Bank historically has maintained a 50-basis-point difference between the two rates but announced in March their plans to narrow the corridor.

Producer Price Index

The Producer Price Index (PPI) August data was published on Thursday of last week, reporting a 0.20% increase in August, increasing 1.70% over the past twelve months. PPI less food, energy, and trade increased 0.30% in August, the same as in July, increasing 3.30% over the past twelve months. This monthly increase can be largely attributed to the 0.40% recorded increase in prices for final demand services, which had previously decreased 0.30% in July. Final demand for goods remained unchanged in August after increasing 0.60% in July. The PPI tends to be a leading indicator of inflation, as producers pass on price fluctuations to their consumers.

Consumer Price Index

August’s Consumer Price Index (CPI) was released on Wednesday of last week, posting a 2.50% twelve-month increase, the smallest increase since February of 2021. Monthly CPI increased 0.20%, the same increase as published in July, while core CPI increased 0.30% in August, up from 0.20% posted in July. Core CPI for the past twelve months came in slightly hotter than expected, reporting a 3.20% increase. Shelter drove most of this uptick, increasing 5.20% over the past twelve months and 0.50% in August. Both Owners’ Equivalent Rent (OER) and the rent index increased by 0.50% and 0.40%, respectively. In contrast, energy fell 0.80% this month, mostly due to the gasoline and natural gas indices, which fell 0.60% and 1.90%, respectively.

Market reaction

Despite last week’s data releases acting as some of the last reports for the Federal Reserve to look to prior to their meeting on Wednesday, August’s CPI and PPI did little to shift market expectations. The Nasdaq, S&P 500, and Dow Jones Industrial Average increased on the day on Wednesday, and the market was still pricing in a minimum 25-basis-point rate cut as of Friday of last week. The CME FedWatch’s probability chart reported on Friday a slightly larger percentage of the market anticipating a 50-basis-point cut this week in comparison to earlier in the week, with 50% of the market pricing in a 25-basis-point cut versus 70% pricing in a 25-basis-point cut as of last Monday. As of this morning, 65% of the market was pricing in a 50-basis-point cut, with the other 35% expecting a 25-basis-point cut.

The week ahead

This week will bring reports of U.S. retail sales as well as housing starts. Most notable will be the Federal Open Market Committee (FOMC) meeting on Wednesday, followed by a press conference and release of the quarterly Summary of Economic Projections by the Federal Reserve.