Introduction to Inflation and Its Impact on the Economy
A key inflation report is looming, and it’s possible that the July data will paint a dismal picture of the economy, whether it shows prices rose or fell. The July consumer price index report is expected to show that prices rose 0.2% last month and 2.8% year-over-year. This reflects a slightly hotter pace of inflation from the prior month, with consumer prices rising 2.7% year-over-year in June.
The Double-Edged Sword of Inflation
Rising inflation is bad, but there’s a chance that falling inflation is taken as a dire warning as well. The logic behind this is twofold:
- If inflation comes in too hot, it will undermine the possibility that the Fed could cut interest rates in September. The Fed resuming rate cuts is a major bullish catalyst that the market has been looking forward to for months. Hotter-than-expected inflation could also be construed as a sign that President Donald Trump’s tariffs are finally starting to raise prices for consumers, which will stoke concerns about the health of the US economy.
- If inflation comes in too cold, that would compound some of the evidence that suggests the US economy is slowing. This is something that markets have been fretting over since the July nonfarm payrolls report showed weak job growth in the month, as well as sharp downward revisions for the prior two months.
Market Reaction to Inflation
In either case, stocks could see a negative reaction following the CPI print, according to Michael Brown, a senior research strategist at Pepperstone. Brown believed the larger downside risk to equities was if inflation came in too hot. If inflation comes in colder-than-expected, any following sell-off could be short-lasting, he said, as investors will quickly pivot their attention to Fed rate cuts on the horizon.
Expert Insights
Justin Weidner, an economist at Deutsche Bank, also sees a potential negative reaction in the market no matter what CPI does. If inflation comes in higher than expected, that makes the calculus for a Fed rate cut in September "more tricky." But if prices are cooler than expected, it could be enough cause for concern about the economy to prompt the Fed to issue a jumbo-sized 50 basis-point rate cut in September. Natalie Gallagher, principal economist at Board, expected inflation to be 2.9%, hotter than consensus estimates. This will likely "mark the beginning of a longer trend," she said, pointing to concerns that inflation could begin to lift off as tariffs work their way through the economy.
Outlook for Fed Rate Cuts
The outlook for Fed rate cuts will largely depend on the trajectory of inflation in the coming months, Brown said. Markets will also be paying close attention to Fed Chair Powell’s comments, particularly at Jackson Hole, where the central bank hosts its annual summer symposium. There’s a chance investors could be getting too complacent about expecting Fed rate cuts, Brown said, pointing to high odds markets see for a September cut. "I’m sort of 50-50 as to whether they pull the trigger in September," Brown said.
Conclusion
In conclusion, the upcoming inflation report has the potential to impact the economy and the market significantly, regardless of whether inflation rises or falls. Investors and experts are closely watching the situation, and the Fed’s decision on rate cuts will depend on the trajectory of inflation. As the market waits with bated breath for the CPI report, one thing is certain: the next few months will be crucial in determining the direction of the US economy.
