U.S. July CPI Falls Below 3% for the First Time in Over Three Years

The U.S. Department of Labor announced on the local time of the 14th that the Consumer Price Index (CPI) in the United States increased by 0.2% month-on-month in July this year; it rose by 2.9% year-on-year, marking the fourth consecutive month of decline and the smallest year-on-year increase since March 2021. How should we interpret the latest inflation data? Does it indicate that inflation stickiness is gradually fading? For related interpretations, let's connect with Yang Shuiqing, a research assistant at the American Studies Institute of the Chinese Academy of Social Sciences.

Service Inflation Stickiness Remains Strong

Yang Shuiqing: The CPI in July was 2.9%, which is basically in line with expectations. In the composition of the CPI, different sub-items have different weights. Specifically, the sub-items related to services in the core CPI still exhibit stickiness. There are two very important components in the CPI: one is related to housing, mainly including actual rent and the equivalent rent of homeowners. These two types of rent together account for 36% of the weight in the CPI basket, which is also the largest item in the CPI basket, and the stickiness remains strong. The second is the medical service sector, which accounts for about 6.5% of the CPI basket. Although this is not a particularly large sub-item, the stickiness is equally strong. In summary, we believe that the service side, especially the parts involving housing and medical care, still has strong stickiness.

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Of course, there are also parts that have declined more rapidly. For example, the energy sector, which accounts for about 7% of the total CPI, has shown a significant decline. Starting from the data released in June, that is, the year-on-year growth rate of energy in May was still 3.6%, but by June and July, it was only around 1%.

Overall, the CPI basket is divided into four major categories: food, energy, goods other than food and energy, and services excluding energy. Within these four frameworks, food inflation is basically stable, the decline in energy year-on-year is rapid, goods excluding food and energy are also very stable, with year-on-year growth basically remaining stable and flat, but the stickiness of the entire service side leads to the year-on-year growth rate of services remaining above 5%.

The Decline of U.S. CPI is Expected to Slow Down

Yang Shuiqing: Therefore, the stickiness of services will slow down the rate of CPI decline. If the Federal Reserve's ideal inflation target is 2.5% or lower, then the main variable to observe for the CPI to drop from the current 2.9% to 2.5% is whether the stickiness on the service side will continue.

Given that the year-on-year growth rate of the service sub-items is still around 5%, and the entire service side, including housing, medical care, and some other services, accounts for 61% of the total CPI weight. Therefore, overall, the stickiness of the service side is very strong and may continue for several months, with the weight proportion reaching over 60%. It is expected that the subsequent decline in CPI will correspondingly slow down.

How will the U.S. stock and bond markets perform in the future?The U.S. CPI in July once again confirmed the trend of cooling inflation, in line with market expectations. After the data was released, the reaction in the U.S. stock and bond markets was generally muted. U.S. Treasury yields rose and then fell, while the three major U.S. stock indices closed slightly higher. As of the close on the 14th local time, the S&P 500 index rose by 0.38%, to 5,455.21 points; the Nasdaq Composite rose by 0.03%, to 17,192.60 points; the Dow Jones Industrial Average rose by 0.61%, to 40,008.39 points.

How does the expectation of interest rate cuts affect the volatility of the U.S. stock market? With the changing interest rate environment in the future, what expectations are there for the subsequent performance of the U.S. bond market? Gan Jingyun, Chief Macro Analyst at Chuangjin HeXin Fund, shares her views with us.

"Preventive Rate Cuts" Benefit the U.S. Stock Market

Gan Jingyun: The impact of interest rate cuts on the volatility of the U.S. stock market is first reflected in the liquidity on the denominator side. Since the Federal Reserve's policy rate is often used as the "pricing anchor" for global major asset classes, as the Federal Reserve's interest rate cut cycle opens and interest rates fall, global liquidity will tend to ease. For the U.S. stock market, the decline in the denominator side interest rate is conducive to the rise in valuations, which is beneficial for the U.S. stock market.

However, interest rate cuts will also affect the pricing of profit expectations on the numerator side. When we analyze, we often need to distinguish between "preventive rate cuts" and "emergency rate cuts." "Preventive rate cuts" refer to an orderly decline in inflation, with the U.S. economy cooling but not losing momentum. At this time, the decline in profit on the numerator side is limited, and the U.S. stock market mostly shows an upward trend, especially the TMT sector, which benefits from liquidity easing, will rise more.

"Emergency rate cuts" are emergency rate cuts in the case of a significant downturn in economic growth and an increased risk of recession. At this time, for the U.S. stock market, although liquidity benefits, concerns about economic recession will suppress profit expectations on the numerator side to a greater extent, which is specifically manifested as a common decline in global risk assets, and the U.S. stock market is also inevitable.

Looking at the current economic situation, the probability of the Federal Reserve's "preventive rate cuts" in the future may be higher, but inflation data and employment data may bring fluctuations to the U.S. stock market in terms of the impact on interest rate cuts and recession expectations.

The overall direction of the interest rate cut cycle is beneficial to U.S. Treasuries

Gan Jingyun: For U.S. Treasuries, as the interest rate cut cycle begins, U.S. Treasury yields will also enter a downward channel, driving a "bond bull market." Both "preventive rate cuts" and "emergency rate cuts" are beneficial to the capital gains of U.S. Treasuries, and if the U.S. economy faces a risk of recession, the fundamental benefits of bonds are even greater.

Of course, the market has also factored in the impact of the Federal Reserve's interest rate cut expectations earlier, so the subsequent yield of the U.S. bond market will also fluctuate with the changes in the Federal Reserve's interest rate cut expectations. For example, if the trend of inflation and labor cooling slows down, and the expectation of interest rate cuts is reduced, U.S. Treasuries will adjust in the short term. If there is an unexpected decline in inflation and growth data, U.S. Treasuries will perform better. We are more inclined to slightly revise down the expectation of a particularly aggressive interest rate cut by the Federal Reserve in the short term, so U.S. Treasuries will have some adjustments in stages, but the overall direction of the interest rate cut cycle is still beneficial to U.S. Treasuries.The Federal Reserve's September rate cut may be imminent

Following the release of the latest U.S. inflation data, expectations for a rate cut in September have been adjusted once again. According to the FedWatch of the Chicago Mercantile Exchange, the market's expectation for a 50 basis point rate cut by the Federal Reserve in September has dropped from 69% a week ago to 37%; the probability of a 25 basis point rate cut has risen from 31% to 63%. Atlanta Fed Chairman Bostic expressed an "open" attitude towards a rate cut in September on the same day, but emphasized that the Federal Reserve must not be "late" in easing monetary policy as signs of cooling in the labor market emerge. How should we view the changes in expectations for the Federal Reserve's September rate cut, and which key indicators will affect the magnitude of the rate cut? What are the expectations for the subsequent rate cut path? Let's listen to the analysis of Zhou Ji, a macro foreign exchange analyst at Nanhua Futures.

The market is divided on the magnitude of the Federal Reserve's September rate cut

Zhou Ji: After the overseas market experienced concerns about a U.S. economic recession triggered by the July non-farm employment data, the decline in the U.S. July CPI data was basically in line with expectations, further confirming the market's judgment on the Federal Reserve's rate cut in September. However, the slight increase in the month-on-month situation has somewhat alleviated the current market's concerns about a U.S. economic recession.

This explains why there is still a divergence in the market's expectations for the magnitude of the Federal Reserve's rate cut in September, as the data shown by the CME (Chicago Mercantile Exchange) FedWatch indicates that the current market's expectations for a 25 or 50 basis point rate cut by the Federal Reserve in September are now roughly evenly split.

Taking into account the recent performance of some overseas economic data and the stance of the Federal Reserve, we expect that it is highly probable for the Federal Reserve to choose a rate cut in September, but it is still necessary to further confirm the subsequent path of the Federal Reserve's rate cuts based on the content of the Jackson Hole meeting in August, which precedes the September interest rate meeting.

A September rate cut does not signify the start of a rate cut cycle

Zhou Ji: In the short term, the U.S. initial jobless claims and retail sales data announced tonight may to some extent affect the market's expectations for a rate cut by the Federal Reserve. However, compared to these two data points, we believe that the inflation data from the United States, such as the U.S. CPI and PCE indicators, as well as the non-farm employment data, will have a greater impact on the market. But regardless of which of the aforementioned data, it may not have a direct relationship with the actual magnitude of the rate cut by the Federal Reserve. We believe that it is still necessary to consider the actual economic growth rate of the United States comprehensively, as it is the actual economic growth rate that will affect, or determine, the magnitude of the rate cut.

As for the expectations for the subsequent path of the Federal Reserve's rate cuts, we anticipate that the timing of the first rate cut by the Federal Reserve within this year is most likely to occur in September or later. However, if the Federal Reserve chooses to implement the first rate cut in September, we believe that this does not mean that the Federal Reserve will start a rate cut cycle.