Tariff-Driven Inflation and Slowing Employment Deepen Fed's Dilemma
September Rate Cut Highly Likely; Scale of Cuts Within the Year in Focus
Three Rate Cuts Possible This Year if CPI Meets Expectations
This week, Wall Street's attention is focused on inflation and consumer data that can reveal the impact of President Donald Trump's tariffs. The weak July employment figures have increased the likelihood of a rate cut in September, and dovish voices within the Federal Reserve (Fed), who favor monetary easing, are gaining strength. As a result, the market sees these upcoming indicators as key variables for gauging the extent of potential rate cuts within the year.
According to the U.S. Department of Labor on August 10 (local time), the July Consumer Price Index (CPI) will be released on August 12. The market expects a 2.8% year-over-year increase, which would be an acceleration from June's 2.7% rise.
The core CPI, which excludes the highly volatile food and energy sectors, is projected to rise by 3.0% year-over-year, surpassing June's 2.9%. Recently, tariffs have started to be reflected in the prices of certain items such as furniture and leisure goods, and retailers are also gradually passing on higher costs to consumers. This could serve as an additional upward pressure on inflation going forward.
The Producer Price Index (PPI) for July, which will be released in the same week, is expected to rise by 0.2% from the previous month, an acceleration from June's 0% change. Retail sales are projected to increase by 0.5%, a slight slowdown from June's 0.6% growth.
Inflation remains persistent, but the variable is the slowdown in the labor market. Nonfarm payrolls in July increased by only 73,000, significantly below the market expectation of 106,000. The job gains for May and June were also sharply revised downward. This trend is strengthening expectations for a resumption of rate cuts in September.
Currently, the United States faces concerns over stagflation, with rising inflation and slowing economic growth occurring simultaneously. To curb inflation, the Fed would need to hold or raise rates, but to prevent further job losses, a rate cut is necessary. This is the Fed's dilemma. With the market strongly anticipating a rate cut in September, if the July CPI meets expectations, demands for additional cuts within the year are likely to intensify both inside and outside the Fed. In the interest rate futures market, the probability that the Fed will cut rates by 0.25 percentage points at the September Federal Open Market Committee (FOMC) meeting is currently about 90%.
Within the Fed, calls for rate cuts are increasing. Board member Christopher Waller and Vice Chair Michelle Bowman advocated for a rate cut in July. Recently, Stephen Miran, a close aide to President Donald Trump who has publicly called for rate cuts, joined the Fed as a new board member. As a result, at least three of the twelve voting members are now considered dovish. On August 9 in Colorado, Vice Chair Bowman stated, "The risk of a labor market slowdown outweighs the risk of rising inflation," expressing her support for three rate cuts of 0.25 percentage points each within the year.
Ultimately, after confirming the inflation trend through the July CPI, the decisive factors for the scale and frequency of rate cuts within the year will be the August CPI and the employment report, both to be released next month. In particular, the August employment report is seen as the key variable; if the unemployment rate exceeds 4.4%, there is speculation about the possibility of a 'big cut' of 0.5 percentage points in September. The market currently assesses the probability of two rate cuts within the year at 52.6%, and the probability of three cuts at 46.7%.
JP Morgan has revised its forecast for rate cuts within the year from one to three. JP Morgan analyst Mike Feroli stated, "The risk management scenario that Chair Powell will consider at the next meeting may go beyond balancing employment and inflation risks," and added, "If the unemployment rate surges in the August employment report, a larger rate cut could be possible. Conversely, if the indicators fall short of expectations, it could trigger an immediate backlash from policymakers focused on inflation."
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