Investors zero in on inflation again, with biggest interest-rate cut in 16 years hanging in the balance

The upcoming Consumer Price Index (CPI) report for August is expected to play a pivotal role in shaping the Federal Reserve's decision on whether to cut interest rates by 25 or 50 basis points at its meeting in less than two weeks.

Inflation data has reemerged as a key focus for financial markets, after taking a backseat to labor market readings in influencing the Fed's potential rate adjustments. A lower-than-expected inflation print on Wednesday could pave the way for a more significant, 50-basis-point rate cut — a move not seen since the height of the 2008 financial crisis.

Recent data revealed that 142,000 new jobs were created last month, fewer than anticipated, adding to speculation that the labor market is slowing. This data, along with downward revisions for July and June, failed to provide clear guidance on the size of the rate cut expected in September.

Wells Fargo economists noted in a recent report, "The August jobs report did little to settle the debate over whether a 25 or 50 basis point rate cut is likely this month. We are leaning toward a 50 basis point cut but acknowledge that 25 basis points remains a real possibility."

Meanwhile, concerns over a sharper-than-expected U.S. economic slowdown triggered a sell-off in stocks last Friday, with the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite all experiencing their worst September starts in over a decade. Short-term Treasury yields dropped as well, with the 10-year rate closing above the 2-year rate for the first time since July 2022, a signal often associated with a potential recession.

Jay Hatfield, CEO of Infrastructure Capital Advisors, noted that Friday's jobs report likely reduces the chance of a 50-basis-point cut, stating, "With 142,000 job gains and a 4.2% unemployment rate, the economy is still showing signs of growth." However, he added that if the Fed were to cut rates by 50 basis points, "it would suggest we're heading for a recession," given the central bank's historically cautious approach.

Market participants are now closely watching Wednesday's CPI report to confirm expectations. Keith Buchanan, Senior Portfolio Manager at Globalt Investments, remarked, "The August CPI data could confirm whether we see a 50-basis-point cut, the largest in quite some time. However, even a cut of that size may not bring us to a fully accommodative position, as rates are still restrictive."

Wall Street is anticipating more positive inflation news, with Barclays and BofA Securities projecting the annual headline CPI rate to fall to 2.5% or 2.6%, down from July’s 2.9%. The core inflation rate is expected to remain steady at 3.2%.

The market will also closely scrutinize the Federal Reserve’s post-meeting announcement and Fed Chair Jerome Powell’s remarks on September 18, as they may provide further insight into how officials are interpreting current economic conditions and the potential risks of a recession.

The five-year TIPS rate has dropped to below 1.7% over the past 12 months, according to Tradeweb data. William Huston, a general partner at Bay Street Capital Holdings in Fremont, California, is among those who have been anticipating lower interest rates for over a year. "There’s a real need for rates to come down," Huston said in a phone interview on Friday. "Globally, we're seeing consumers spend less and businesses hold back on investments, so a 50-basis-point cut would be welcomed."

The key data point of the upcoming week is Wednesday’s Consumer Price Index (CPI) report.

Other notable reports include Monday's wholesale inventories for July and consumer credit data for August. On Tuesday, the National Federation of Independent Business will release its optimism index for August.

On Thursday, weekly initial jobless claims and the August Producer Price Index (PPI) will be published. Friday will feature a consumer sentiment reading for September and the import-price index for August.