Investors could be in for an unexpected jolt if the upcoming Consumer Price Index (CPI) report scheduled for Wednesday reveals higher-than-anticipated inflation figures, according to a warning from Gavekal Research. The markets have been operating under the assumption that the Federal Reserve will soon begin a series of aggressive interest rate cuts, a belief that could be severely tested if inflation rears its head once more.
Currently, the futures market is signaling a 100% certainty that the Federal Reserve will cut rates during its September 18 meeting, with a 50% likelihood of a more substantial cut of 50 basis points. There is also a prevailing expectation that the Fed will implement a total of 100 basis points in rate cuts by the end of 2024. However, Gavekal cautions that if inflation data comes in stronger than expected, it could force a “violent position adjustment” in the markets, as investors are compelled to reassess the Fed’s likely path forward.
The team at Gavekal is divided on what the future holds, reflecting broader market uncertainty. Some analysts within the firm argue that structural factors could push inflation above the Fed’s 2% target, suggesting that inflationary pressures may persist. On the other hand, others believe that a contraction in the money supply and the easing of previous supply chain bottlenecks will help to curb inflation, keeping it in check.
Adding to this complex picture is the July employment report, which indicated that the labor market is continuing to cool. This cooling effect implies that wage growth may moderate further, reinforcing the narrative of disinflation. At the margins, this would support the case for rate cuts. However, as Gavekal points out, any uptick in inflation could quickly undermine this narrative, at least in the short term.
The Federal Reserve’s willingness to cut rates largely depends on inflation behaving as expected. Should inflation surprise on the upside, the Fed might be forced to delay its anticipated rate cuts. This scenario could lead to a rebound in the U.S. dollar, rising bond yields, and increased pressure on U.S. equities, particularly growth stocks, which are more sensitive to interest rate changes.
In light of these potential risks, Gavekal suggests that the safest investments might be in U.S. dollar cash, Treasury bills (T-bills), and inflation-protected Treasury securities. Given the significant uncertainties surrounding the upcoming CPI release, it would be wise for investors to prepare for potential market volatility on Wednesday.
With so much depending on the inflation data, the upcoming CPI report is crucial. A higher-than-expected inflation figure could not only upset market expectations but also compel a broader re-evaluation of economic strategies as the year progresses. Investors are advised to stay vigilant and consider protective measures against possible market turbulence.