August inflation seals the deal for rate cuts next week

Inflation dropped like a rock last month, giving the Fed ample justification to move forward with rate cuts next week.

According to the Department of Labor, the Consumer Price Index (CPI) rose by 2.5% in the 12 months through August, decreasing from 2.9% in July.

It was the lowest annual reading in more than three years and below the consensus forecast, which called for 2.6%.

August marked the fifth consecutive month of cooling headline inflation, adding to a growing body of evidence showing consumer prices are moderating across the economy.

Since peaking at 9.1% in mid-2022, the CPI has been on a downward trajectory for most of the past two years.

“Today’s report will add to confidence within the Fed that inflation is indeed on a sustained path towards 2%,” said Carl Weinberg, chief economist at High Frequency Economics.

While the Fed has made it abundantly clear that it plans to lower interest rates next week, the CPI report could give policymakers more leeway to consider jumbo-sized rate cuts.

The data gives economists “hopium”

According to Laura Veldkamp, a finance and economics professor at Columbia University, the Fed has “gotten really close” to its 2% inflation target.

“This battle against inflation is more or less done,” said Veldkamp.

WisdomTree macro strategist Samuel Rines, who doesn't rule out a half-percentage-point cut, said the report “was a lot more optimism than anything else for 50 basis points in September.”

While this remains only a remote possibility, the macro strategist thinks progress on inflation would open up another debate about jumbo-sized cuts when the Fed meets again in November.

Another argument for jumbo cuts is a weakening job market, with more Americans out of work and job openings down over the past year.

Economists say rising unemployment can be a precursor to a recession.

Some metrics, such as the Sahm Rule and the Schannep Recession Indicator, suggest that the economy is already in a downturn because of rising unemployment.

Macquarie strategists believe a recession would become “much likelier” if the Fed doesn’t cut interest rates. They cited growing consumer pessimism about the labor market and economy as reasons to be alarmed.

Whether the central bank can dodge a recession remains to be seen. Several economists, including TS Lombard’s Steve Blitz, are convinced the Fed has waited too long.

In their view, this "wait-and-see" approach could ultimately drag the economy into a recession, regardless of the number or size of rate cuts.

According to CME Group’s FedWatch Tool, markets are pricing in a standard 0.25% reduction at each of the remaining three policy meetings this year.