U.S. Inflation Declines, However, Service Price Rigidity Persists

U.S. inflation data signals that price pressures are easing, albeit not quickly. Nevertheless, persistent concerns about the labor market are keeping market expectations alive for a 50 basis point rate cut by the Federal Reserve (Fed) at next week's meeting.

On Wednesday, the Consumer Price Index (CPI) showed that headline inflation declined from 2.9% to 2.5%, marking the lowest annual increase since February 2021. In contrast, core inflation held steady at 3.2%, unchanged from the previous month.

The primary driver of inflation was a 5.2% increase in the shelter index, while the easing was mainly due to a 4% drop in the energy index. Services inflation, on the other hand, remained steady at 4.9% year-over-year.

Meanwhile, the Producer Price Index (PPI) report released yesterday revealed that producer prices in the U.S. rose by 0.2% in August monthly, surpassing expectations of a 0.1% increase. However, the annual headline PPI rose by 1.7%, falling short of the expected 1.8%. This indicates a notable slowdown from the previous 2.1% and marks the lowest increase since early 2024.

Additionally, excluding food and energy, producer prices increased by 0.3% on the month, exceeding expectations, while the year-over-year figure remained flat at 2.4%.

The PPI report suggests that the monthly rise in producer prices was primarily driven by a 0.4% increase in service costs. While goods prices remained relatively unchanged, the overall index decline was supported by falling energy prices.

In summary, U.S. inflation reports indicate that while goods prices are easing, service prices remain stubbornly high. Besides, the primary tailwind behind this month's declining indices was the drop in energy prices.

Markets Split on Fed's Next Move: Labor Market Risks Overshadow Inflation Concerns

Following the CPI report, expectations for a 25-basis-point rate cut in the interest rate futures markets rose to 87%, while the odds for a 50-basis-point jumbo cut dropped to 13%.

Indeed, the data does not present a picture that would fully ease the Fed's concerns regarding inflation risks. However, markets assess that the risks to the labor market are greater than those to inflation, and they expect the Fed to take steps to prevent further cooling of the labor market.

Yesterday’s Initial Jobless Claims report showed that unemployment claims reached 230K for the week ending September 6, slightly above the median estimate of 226K from Bloomberg's economist survey. Continuing claims also rose to 1.85 million for the week ending August 31.

In the first half of the year, unemployment claims averaged around 215K, but since July, the average has climbed above 230K. The upward trend in unemployment, combined with downward revisions in nonfarm payroll figures, fuels concerns that the U.S. economy is heading toward a recession.

Wall Street banks such as Citigroup Inc., JPMorgan Chase & Co., and Wells Fargo & Co. expect the Fed to be more aggressive in its upcoming meeting. While a 25 basis point cut remains the base case at 55%, the 45% probability of a 50 basis point cut indicates the market is almost evenly split.

The Fed is generally known for avoiding market surprises, but the uncertainty in market expectations ahead of the meeting is unusual. With Fed officials in a blackout period before the policy decision, market pricing seems to continue to be driven by speculation until the Fed announces its final decision.

ECB Cuts Rates, Lagarde Points to Data as Key for Next Steps

The European Central Bank (ECB) cut interest rates for the second time this year yesterday. As forecasted by all economists surveyed by Bloomberg, the reduction was 25 basis points, bringing the deposit facility rate down to 3.5%.

One notable aspect of the ECB's economic projections was that the inflation forecasts were not revised; for 2025 and 2026, they were left unchanged at 2.2% and 1.9%, respectively. The ECB still anticipates that inflation will reach its 2% target in the second half of 2025.

On the other hand, the growth forecast was slightly revised downward, from 0.9% to 0.8%. This suggests that ECB policymakers remain cautiously optimistic about the economy's state.

Following the meeting, President Christine Lagarde stated that the 2% inflation target is clearly within sight, though wage growth remains high and volatile. She noted that the economy faces some headwinds but added that a less restrictive monetary policy should eventually support consumption and investment.

Before the meeting, markets had priced in around a 40% chance of an additional rate cut in October. However, Lagarde’s remarks did not provide sufficient guidance regarding the timing of the next rate cut. Her emphasis on data dependency led to a reduction in expectations for an October rate cut, bringing the odds down to around 20%.

Markets are now pricing in a total of 36 basis points of rate cuts by the end of the year. Economists believe that while Lagarde’s comments did not rule out a cut in October, it appears unlikely. In this context, expectations for rate cuts to occur at a quarterly pace seem more reasonable.

Gold Reaches New All-Time High on Fed Rate Cut Speculation

Gold price surged by approximately 2% yesterday, reaching a new all-time high. After starting the day around $2,515 per ounce, gold is currently trading above $2,565.

Yesterday, the release of U.S. data coincided with the ECB’s decision to cut interest rates, providing strong tailwinds for gold’s rally. Following the U.S. data, market participants’ expectations for a jumbo rate cut from the Fed reignited.

As bets on Fed rate cuts increase, U.S. Treasury yields continue to decline. The 2-year yields dropped to 3.59%, the lowest since November 2022, while 10-year benchmark yields fell to 3.64%, marking the lowest level since May 2023.

Non-yielding gold, which has risen by nearly a quarter since the start of the year, continues to break records. The rally is fueled not only by the easing cycle of global central banks but also by geopolitical conflicts, strong central bank purchases, and rising demand for safe-haven assets.

Crude Oil Prices Rise on Supply Concerns but Demand Outlook Remains Grim

Crude oil prices are under downward pressure due to concerns over global demand, despite OPEC's decision to delay easing supply restrictions.

These concerns primarily stem from uncertainties surrounding the economic outlook of China, the world's largest oil importer. The International Energy Agency’s (IEA) monthly report revealed that global crude oil consumption growth has slowed to its lowest since the pandemic, largely due to China’s ongoing struggles to recover.

The weakening demand outlook for the U.S. and Eurozone economies also presents a bearish picture for oil demand. Economists predict that crude oil prices could drop to $60 per barrel by 2025.

Meanwhile, concerns over supply led crude oil prices to post their first weekly gain in over a month. Prices surged after Storm Francine caused significant disruptions in production in the Gulf of Mexico.

Furthermore, the expected rate cuts from the Fed are also supporting the upward movements in crude oil prices. However, unless demand concerns ease, the upside potential for prices will likely remain limited.