The August CPI was released last night. Headline CPI came in largely within expectations while core CPI surprised slightly to the upside. Markets initially sold off but rebounded strongly to close higher for the day.
The mood has been somber since late July as weaker-than-expected job numbers led to recession worries. Therefore, going into the CPI release, the fear is that inflation would be reported as much softer than expected. The market would interpret a soft inflation reading as weakening demand from consumers. This fear was dispelled after the CPI release. The not-too-hot, not-too-cold “Goldilocks” scenario is now back in play and markets are re-pricing accordingly.
Post CPI Market Reaction
After the initial sell-off in equities, risky assets made a strong comeback. The S&P 500 closed up 1.07%.
At the same time, rate cut expectations got dialed back. Most market participants are now expecting a 25bps rate cut.
As recession fears recede, protective hedges are no longer needed and quickly discarded. This manifested in the convincing drop in the VIX.
Upcoming FOMC Meeting
The next Federal Open Market Committee (FOMC) meeting will be held next week from 17 to 18 September. After the latest market re-pricing post-CPI, Jerome Powell can confidently announce a 25bps rate cut. This is also what he wants. During his speech at Jackson Hole, he clearly stated that the risk is tilted towards the labor market so he is likely to err on supporting the labor market rather than fighting inflation. However, he likely doesn’t want to cut by 50bps since that might signal desperation. From the market's perspective, participants would like the Fed funds rate to be reduced because inflation is coming down and not as a response to fight a recession.
US Presidential Campaign
The US Presidential campaign is currently ongoing. It seems like both candidates are running neck to neck. This might cause volatility to stay elevated. However, regardless of who becomes President, it is unlikely to derail the stronger underlying economic forces in the long run.
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