The August Consumer Price Index (CPI) report, which showed a 0.2% month-over-month increase in August and a year-over-year rate of 2.5% (down from 2.9% in July), offered the Federal Reserve a plausible reason to keep interest rates steady. This outcome aligns with expectations that the Fed would avoid a rate hike, a sentiment supported by Governor Waller's preference to hold rates as long as inflation data permits. While the report showed continued progress towards the Fed's 2.0% inflation target, the market's enthusiasm for a larger 50-basis point rate cut at the upcoming meeting has diminished, with an 18% chance priced in, down from 33% the previous day.
Despite the overall positive trend in inflation, the report highlighted persistent increases in services (+0.4%) and housing (+0.5%) costs. However, these were offset by declines in other key categories, including energy (-0.8%), goods (-0.2%), used vehicles (-1.0%), medical care commodities (-0.2%), and medical care services (-0.1%). Core CPI, excluding volatile food and energy prices, rose 0.3% month-over-month, slightly above consensus, but its year-over-year rate held steady at 3.2%. The three-month moving averages for core and super-core CPI are now close to the Fed's target, at 2.1% and 1.9% annualized, respectively.
Financial markets reacted with S&P 500 equity futures trading lower, and Treasury bond yields seeing a slight increase, with the 2-Year yield up 7 basis points and the 10-Year yield up 4 basis points. This mixed reaction reflects the report's "good but not great" nature. While the data supports a September rate cut, the specifics, particularly the firm services and housing inflation, temper expectations for a more aggressive 50-basis point reduction. The upcoming changes to the methodology for calculating PCE inflation, the Fed’s preferred measure, in late September are also a factor, with some analysts suggesting these changes could lower year-over-year core PCE by 0.2 percentage points.
