Investors renew focus on inflation data as Fed weighs size of expected September rate cut

By Vivien Lou Chen

The big question for market participants is whether a 50-basis-point rate cut would mean a recessionary environment `is more probable than the Fed is comfortable with,' one portfolio manager says.

A previous version of this article incorrectly stated that a 50-basis-point interest-rate cut from the Federal Reserve on Sept. 18 would be its largest since late 2008. This has been corrected to reflect that the Fed moved to cut rates by 50 basis points and 100 basis points in March 2020.

Inflation data is back at the forefront again in the minds of financial-market participants, after taking a back seat to labor-market readings in terms of relevance for the likeliest path of U.S. interest rates. Wednesday's consumer-price index for August may end up being the deciding factor as to whether the Federal Reserve will deliver a bigger-than-usual, 50-basis-point rate cut on Sept. 18. The U.S. central bank hasn't lowered borrowing costs by that much at one time since the U.S. onset of the Covid-19 pandemic in March 2020. For now, one of the biggest questions for investors is whether a soft inflation print on Wednesday that clears the way for a half-percentage-point reduction in less than two weeks would be seen as good or bad news. Friday's data revealed 142,000 new jobs were created last month, fewer than expected - reinforcing the view that the labor market is slowing. The report was accompanied by downward revisions to July and June that unsettled investors, and failed to fully resolve the question of how big September's Fed rate cut might be.

"The August jobs report did little to settle the debate if a 25 bps or 50 bps rate cut is coming this month. We're sticking with 50 bps, but acknowledge 25 bps as a real possibility," wrote economists at Wells Fargo in a Friday note.Meanwhile, fears of a steeper-than-expected U.S. economic slowdown led to a selloff in U.S. stocks on Friday - leaving the Dow Jones Industrial Average DJIA, S&P 500 SPX, and Nasdaq Composite COMP with the worst starts to the month of September in well over a decade. Short-term Treasury yields plunged, enabling the benchmark 10-year rate to finish above its 2-year counterpart for the first time since July 1, 2022.

Read: The stock market is stumbling on nagging fears the Fed may have made a mistakeAccording to Jay Hatfield, chief executive of New York-based Infrastructure Capital Advisors, which has around $2.2 billion in managed assets, Friday's jobs data takes the likelihood of a half-point rate cut off the table for September because 142,000 job gains and a 4.2% unemployment rate are still consistent with a normal, growing economy. However, if the Fed does deliver a half-point reduction this month, "that means we are definitely going into a recession," considering policy makers have been behind the curve in the past and have stuck by a careful approach on lowering interest rates, Hatfield added.

Archive: Stock-market drop offers reminder that rate cuts don't always cheer investors (July 25)Fed-funds futures swung in both directions on Friday amid some confusion over how to interpret post-data remarks made by Fed Governor Christopher Waller. Traders briefly priced in a 79% chance of a half-point rate cut on Sept. 18, then moved in the other direction with a 71% likelihood of a regular quarter-point move.

Elyse Ausenbaugh, head of investment strategy at J.P. Morgan Wealth Management in New York, and Emily Roland, co-chief investment strategist for John Hancock Investment Management in Boston, were among those who suggested the August CPI report could be an important deciding factor.

The August CPI report is "going to confirm or not confirm expectations for a 50-basis-point cut, the biggest cut in a very long time," said Keith Buchanan, a senior portfolio manager at Globalt Investments in Atlanta, which oversees $2.5 billion. "Rates are growing more and more restrictive as inflation has come down, so bringing the target rate down by 50 basis points isn't necessarily going to completely move us to an accommodative position." "The $64,000 question is whether a 50-basis-point rate cut would mean we've gone too far and too long with 5%-plus interest rates, things are too soft, and therefore a recessionary environment is more probable than the Fed is comfortable with," Buchanan said via phone on Friday. The S&P 500 SPX is still trading at roughly 21 times next year's earnings - or a level that does not imply a recession is on the way - so "the pricing of all financial instruments will be impacted by the rhetoric and tone of the next Fed policy announcement," the portfolio manager said. Financial-market participants are going to be "laser-focused" on what Fed Chair Jerome Powell says at his post-meeting press conference on Sept. 18, and whether he indicates officials are "afraid of how fast things are softening and are ready to do more." For now, Wall Street is expecting Wednesday's CPI data to add to a recent string of good news on inflation. Teams at Barclays and BofA Securities expect the annual headline CPI rate to come at 2.5% or 2.6%, respectively - the latter of which is in line with the consensus forecast. That's down from a 2.9% reading in July. They also expect the narrower core rate to remain at 3.2% on a year-over-year basis after accounting for a roughly 0.2% monthly increase in August.Meanwhile, yields on Treasury inflation-protected securities, which tend to reflect the market's sentiment on government-borrowing costs, inflation, the economy, and monetary policy, have been dropping. On Friday, the 10-year TIPS yield hovered around 1.69%, close to its lowest level since the end of December, according to Tradeweb. The 5-year TIPS rate has also been falling over the past 12 months, to 1.64%.

William Huston, a Fremont, California-based general partner at investment firm Bay Street Capital Holdings, said he's in the camp of people who have been awaiting lower interest rates for more than a year. "There's a real need for rates to come down," Huston said via phone on Friday. "On a global basis, you're seeing consumers spending less money and businesses pulling back on investing. So a 50-basis-point cut would be welcome."

Wednesday's CPI report is the data highlight of the coming week. Monday brings data on wholesale inventories for July and consumer credit in August. On Tuesday, the National Federation of Independent Business optimism index for August is scheduled to be released. Weekly initial jobless claims and the August producer-price index are set to arrive on Thursday. Friday brings a consumer-sentiment reading for September and the import-price index for August.

-Vivien Lou Chen

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09-18-24 1810ET

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