July CPI Data: Conflicting Economic Scenarios
The United States is scheduled to release the Consumer Price Index (CPI) data for July on Tuesday, data that holds the potential to paint a bleak picture for the American economy, regardless of whether it points to rising or falling inflation.
Market consensus suggests the July CPI report will show a 0.2% increase month-over-month and a 2.8% increase year-over-year. Core CPI, which excludes volatile food and energy prices, is expected to rise 0.3% month-over-month and 3% year-over-year.
While rising inflation is generally considered a bad thing, a drop in inflation could also be seen as a worrying warning. If the inflation data is "hot" (higher than expected), it will weaken the likelihood of the Federal Reserve cutting interest rates in September. A return to interest rate cuts by the Federal Reserve is seen as a major bullish catalyst the market has been anticipating for months.
Higher-than-expected inflation could also be interpreted as a sign that former US President Donald Trump's tariffs are finally starting to push up consumer prices, which would raise concerns about the economic health of the United States. Conversely, if the inflation data is "cold" (lower than expected), it will add to the evidence suggesting the US economy is slowing, something the market has been worried about since the July nonfarm payrolls report showed weak job growth and significant downward revisions to the previous two months' data.
Potential Market Reactions
Michael Brown, senior research strategist at Pepperstone, indicates that US stocks could experience a negative reaction after the release of the CPI data, regardless of the scenario. Brown believes the biggest risk facing the stock market is "hot" inflation data. He adds that if inflation is lower than expected, any subsequent sell-offs may be short-lived, as investors will quickly turn their attention to the upcoming interest rate cut by the Federal Reserve.
Brown continues: "If we get a hot number, suddenly, the doubts surrounding the September meeting will increase significantly, and we may suddenly face some headwinds for the stock market because we are pricing in an economic slowdown."
After the July labor market proved to be much weaker than expected, investors began pricing in an interest rate cut by the Federal Reserve in September with greater certainty. According to the Chicago Mercantile Exchange's FedWatch tool, the market sees an 86.5% probability of a 25 basis point rate cut in September, slightly lower than 90.4% the previous week.
Justin Weidner, an economist at Deutsche Bank, also believes that the market may experience a negative reaction regardless of the CPI data. He points out that if inflation is higher than expected, it will make the calculations for interest rate cuts by the Federal Reserve in September "more difficult." But if prices are lower than expected, it may be enough to raise concerns about the economy, which could push the Federal Reserve to make a "very large 50 basis point" cut in September. Weidner adds, speaking about the potential reaction of the stock market: "On the other hand, if it's a little weak, weaker than expected, you'll see some corrections."
Natalie Gallagher, chief economist at Board, believes that the risks of the CPI report are two-way. Gallagher says she expects inflation to reach 2.9%, higher than the general consensus. She says in a report that this could "mark the beginning of a longer trend," noting that inflation may begin to rise as tariffs begin to appear in the economy.
She adds: "The real surprise would be if these pressures don't show up, which would indicate that demand is so weak that companies can't raise prices, which is a worrying sign for US growth."
Brown says that the outlook for interest rate cuts by the Federal Reserve will depend mainly on the path of inflation in the coming months. The market will also closely monitor the comments of Federal Reserve Chairman Jerome Powell, especially his speech in Jackson Hole, where the Federal Reserve will hold its annual summer seminar.
Brown also believes that investors may become too complacent about the outlook for interest rate cuts by the Federal Reserve, noting the high probability the market sees for an interest rate cut in September. Brown concludes:
"Will they pull the trigger in September? I think the odds are about 50/50, and you might say that maybe they should cut interest rates, but this is the Federal Reserve that was 'bitten' by runaway inflation not long ago, and I think that memory will still be very present in the minds of Federal Reserve officials."
Potential Implications for the Global Economy
In addition to its direct impact on the US economy, July's CPI data could have significant implications for the global economy. If the data leads the Federal Reserve to delay or cancel interest rate cuts, this could lead to a rise in the value of the US dollar, which could harm emerging economies that rely on debt denominated in dollars. Higher interest rates in the United States could also lead to a slowdown in global economic growth, as they reduce investment and consumer spending.
Conversely, if the CPI data indicates a slowdown in the US economy, this could push the Federal Reserve to cut interest rates significantly, which could stimulate global economic growth. However, cutting interest rates could also lead to higher inflation, which could create new challenges for economies around the world.
In short, July's CPI data represents a crucial moment for the US and global economies. Markets will be closely watching this data to assess the path of inflation and the Federal Reserve's outlook for interest rates, and make appropriate decisions accordingly.
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