Market Focuses on US CPI, Key to Fed's Rate Cut Pause

2024-08-21 144 Comments

Wall Street financial giant Bank of America recently released a report stating that after the incredibly strong September non-farm employment data and the unexpected drop in the unemployment rate shattered expectations for Federal Reserve rate cuts, the importance of this week's upcoming Consumer Price Index (CPI) report has significantly increased. CPI data that is higher than the market's general expectations may lead investors to increasingly doubt whether the Federal Reserve will choose to cut rates next month. For months, non-farm employment has been the most closely watched U.S. economic data by global investors because the strength of non-farm data is crucial for the pace and rhythm of Federal Reserve rate cuts. However, this week investors are refocusing on the U.S. CPI report, which is crucial for whether the Federal Reserve will continue to cut rates this year. The September CPI statistics will be announced on Thursday evening Beijing time.

The newly released incredibly strong U.S. non-farm employment data, along with the unexpected drop in the unemployment rate, has led traders to significantly reduce their bets on the Federal Reserve continuing to cut rates by 50 basis points. For the first time since August 1, the interest rate futures market pricing implies that the Federal Reserve's benchmark rate cut by the end of the year will be less than 50 basis points, which means that some traders are even pricing in the possibility that the Federal Reserve may pause the rate cut process at the November or December FOMC meetings before the end of the year.

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Traders in the interest rate futures market now believe that there is an 85% chance that the Federal Reserve will shift to a 25 basis point rate cut in November. In contrast, before the non-farm employment report was released, the bond market's bets on a 25 basis point rate cut barely exceeded 50%, while the probability of a 50 basis point rate cut was once higher than 25 basis points.

In the U.S. Treasury trading market, as most global bond traders abandon their bullish bets on U.S. Treasuries for at least the short term, it has pushed the yield on the 10-year U.S. Treasury, known as the "anchor of global asset pricing," to its highest level since August, breaking through the key U.S. Treasury yield threshold of 4%. The performance of short-term U.S. Treasuries with a maturity of 2 years or less is particularly poor, marking a temporary reversal of a key part of the U.S. Treasury yield curve trend, highlighting a significant cooling of the bond market's expectations for the Federal Reserve's future rate cut path.

Interest rate strategists from TD Securities said: "The market's focus, and even the discussion, is shifting towards whether further rate cuts will continue." "From an economic perspective, the situation is not so bad, leading the market to reprice the Federal Reserve's rate cut path." TD continues to expect the Federal Reserve to choose a 25 basis point rate cut in November, rather than continuing to insist on a 50 basis point rate cut.

It is understood that data released by the U.S. government on Friday showed that after the non-farm employment number was revised upward by 72,000 in the previous two months, the non-farm employment number in September increased by 254,000, far exceeding expectations and setting a six-month record for the largest increase in non-farm employment. In contrast, the median expectation of economists was only 150,000, and the latest non-farm employment exceeded the most optimistic expectation shown by media surveys. According to another set of data released by the U.S. Bureau of Labor Statistics on Friday, the unemployment rate unexpectedly fell to 4.1%, and average hourly earnings increased by 0.4% month-on-month, both higher than economists' expectations (4.2% for the unemployment rate and 0.3% for average hourly earnings growth).

Combined with other data released last week, it shows that U.S. companies still have a healthy demand for workers, and the number of layoffs remains very low. Coupled with earlier economic data showing the resilience of the U.S. economy, the non-farm employment report may significantly alleviate economists' concerns about the U.S. labor market cooling too quickly and the risk of economic recession. The situation in the U.S. labor market is closely related to U.S. consumer spending, and the scale of employment and wage income are crucial for overall consumption. The resilience of consumer spending will undoubtedly strongly drive the U.S. economic giant to continue sailing, after all, 70%-80% of the items in the U.S. GDP are closely related to consumption.

Bank of America predicts: If CPI is higher than expected, the "pause rate cut" expectation may sweep the financial market.

The September U.S. CPI data to be released this week may make the market's judgment of the Federal Reserve's rate cut path clearer. Bank of America forecasts that the U.S. core CPI index will increase by 0.3% month-on-month in September, basically in line with economists' expectations. If this expectation becomes a reality, it may lead to two consecutive strong core CPI indices. In terms of overall CPI expectations, Bank of America's expectations are consistent with the 0.1% month-on-month increase widely expected by economists covered by institutional surveys, which may be the smallest increase in three months. In terms of year-on-year growth, economists generally expect the overall CPI to grow by 2.3% in September, down from the previous value of 2.5%; the core CPI is expected to grow by 3.2% year-on-year, consistent with the previous value.

Ohsung Kwon, an equity and quantitative strategist at Bank of America, said in a report released on Sunday: "If our forecast proves to be correct, it will further consolidate the market's expectation that the Federal Reserve will choose a 25 basis point rate cut in November." "At the same time, inflation is unlikely to be weak enough to ensure a 50 basis point rate cut, but if inflation data is very strong, it may make the Federal Reserve's rate cut process in November less certain, and the market's call for a pause in rate cuts may become more intense." This crucial CPI report will be released on Thursday evening Beijing time.Ohsung Kwon's strategy team at Bank of America has indicated that following the release of the employment report, the market's forecast for the Federal Reserve's interest rate cuts before the end of the year is less than 50 basis points. However, the U.S. stock market has risen due to increasing expectations of a "soft landing" for the U.S. economy. After the release of the non-farm employment report, financial market traders have essentially ruled out the possibility of the Federal Reserve continuing to make significant interest rate cuts of 50 basis points in November.

Strategist Kwon does not believe there is a substantial upside risk to the latest inflation forecast from Bank of America. "Although the increase in non-farm employment in September was stronger than the market expected, the overall labor market data suggests that demand and supply are in a better balance," said the team led by the strategist. "In fact, the continued downward trend in exit rates indicates that wage and price inflation should continue to moderate."

Kwon stated that the options market anticipates that the expected volatility brought by the Consumer Price Index report will cause the U.S. stock market benchmark index—the S&P 500—to fluctuate by about 109 basis points this Thursday, up from the 91 basis points fluctuation last week, which will also be the largest scale of U.S. stock market fluctuation on a "U.S. Consumer Price Index Day" since May. The average fluctuation of the S&P 500 index over a three-month benchmark period is currently around 70 basis points.

The strategist also said, "Although the U.S. stock market should be able to withstand a slight upside surprise in inflation due to the continued improvement of more macroeconomic data, a significant surprise exceeding expectations could bring a lot of uncertainty to the Federal Reserve's easing cycle and cause larger fluctuations in the stock market."

According to the "FedWatch Tool" of the Chicago Mercantile Exchange (CME), during the decline of U.S. Treasury bond prices across all maturities on Monday due to expectations of interest rate cuts, the probability of the Federal Reserve remaining unchanged next month jumped from 2.6% on Friday to 15.8%, while the probability of a routine 25 basis point rate cut dropped from a high of 97.4% to 84.2%, with the voices calling for a 50 basis point rate cut virtually disappearing. These latest interest rate cut probabilities compiled by CME imply that an increasing number of interest rate futures traders are betting that the Federal Reserve's next rate cut will be a routine 25 basis point pace, and some more aggressive traders are betting that the hot non-farm data will push inflation back up, thereby prompting the Federal Reserve to choose not to cut rates in November or December.

The economist team of Citigroup, a major Wall Street bank, said in a report on Monday that they expect the Federal Reserve to cut rates by 25 basis points in November, rather than the 50 basis points previously expected by the group. After the September non-farm employment data released on Friday suggested that the U.S. economy remains strong, Citigroup joined other Wall Street banks in abandoning the aggressive forecast of a 50 basis point rate cut.

The Citigroup economists wrote in the report: "The bar for the Federal Reserve not to cut rates in November is quite high, as one month of labor market data does not convincingly reduce the economic downside risks that have persisted for several months, and many datasets have driven Federal Reserve officials to choose a 50 basis point rate cut in September." "We believe that weakness in the labor market will reappear in the coming months, and the overall trend of inflation will continue to slow down, which may prompt Federal Reserve officials to choose a 50 basis point rate cut in December."

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