Markets Hope Inflation Remains Stable, According to Reuters

Market Update Overview from Mike Dolan

As the week begins, key inflation updates from the U.S. will likely influence the Federal Reserve’s approach to interest rates amidst heightened expectations for a potential cut next month. The recent market volatility, particularly centered in Tokyo, has calmed, presenting a stark contrast to last week’s chaotic trading environment.

Despite significant fluctuations, the market closed last week mostly unchanged, and the volatility index has settled around long-term averages near 20. Growing concerns about the U.S. labor market were alleviated by a decline in weekly jobless claims, and the overall earnings landscape remains strong, with S&P 500 profit growth nearing 14% for the second quarter as the reporting season concludes.

Job-related anxieties and recent market turbulence have led to increased speculation around Fed rate cuts, with futures suggesting a probability of a quarter- to half-point reduction next month, alongside an anticipated easing totaling 102 basis points by year-end. The Fed’s decision-making will heavily depend on upcoming inflation data.

This week will see the release of the producer price index (PPI) report on Tuesday, which is expected to show a continued softness, with annual PPI projected at around 2.3% for July. The consumer price index (CPI) is also anticipated to reflect modest figures, with monthly increases around 0.2% and core annual inflation forecast to slightly drop to 3.2%. If these expectations hold true, it could signal a conducive environment for the Fed to consider lowering rates, provided disinflation trends persist.

Federal Reserve Governor Michelle Bowman recently indicated that should the inflation data consistently trend toward the 2% target, reducing the federal funds rate could be necessary to avoid overly restrictive monetary policy affecting economic activity and employment. However, she also suggested that the July employment report may have overstated the cooling of the labor market, tempering expectations for aggressive rate cuts.

On Monday, the New York Fed will release its latest household inflation expectations survey, which has shown recent declines in median 3- and 5-year forecasts to below 3%. Market sentiment appears to reflect a similar downward adjustment in inflation expectations during recent turbulence. The ten-year breakeven inflation rates in Treasury securities dropped close to the Fed’s 2% target, marking their lowest levels since early 2021, although they have since firmed to 2.1%.

As the week kicks off, Treasury yields are slightly higher but remain below the 4.0% mark recently crossed. Wall Street stock futures and European indexes are experiencing modest increases, while Chinese mainland stocks lag, focused on recent shifts in the government’s bond market.

Notable market developments are anticipated later on Monday, including the New York Fed’s inflation expectations survey and the U.S. Treasury’s auction of 3- and 6-month bills.