Inflation Data Next Week in Focus

The market is currently pricing in tame inflation data for next week, as stocks recover to near all-time highs and volatility remains at relatively low levels. On Tuesday morning, the Consumer Price Index (CPI) will take center stage, with expectations for a 0.2% month-over-month increase in Headline CPI, down from 0.3% in July. This deceleration is likely to be a welcome sign for traders and investors.

However, Core CPI is expected to show a slight acceleration, with the current Bloomberg estimate forecasting a 0.3% month-over-month increase, compared to the 0.2% rise the previous month.

One of the more popular inflation models, the Cleveland Federal Reserve’s Inflation Nowcast, has garnered attention for its accuracy in predicting inflation levels. Last month, the Cleveland Fed accurately projected the rise in headline inflation, which had been underestimated by the markets. This time around, the Cleveland Fed expects Core CPI to come in lower than market expectations, a development that would likely be positive for equity market bulls.

A softer Core CPI reading could provide the Federal Reserve with additional justification to cut rates in September, potentially even by 50 basis points. A 50 basis point rate cut would gain broader support from the market if inflation remains subdued and the labor market shows mild signs of deterioration. Currently, the CME FedWatch Tool is pricing in a 90% probability of a 25 basis point rate cut.

So, where’s the risk next week? A surprise uptick in Core CPI could trigger concern, as Core CPI is often viewed as a reliable gauge for “services” inflation, which tends to be stickier and slower to subside. With the VIX currently sitting around 15, complacency has returned to the markets. Any unexpected shift in economic data could rerate volatility higher, potentially sparking another market pullback.