At a time when the labor market is deteriorating, Thursday’s consumer-price index report for August could confirm that the service side of inflation is still problematic.
The Federal Reserve’s anticipation for interest-rate decreases beyond September may be dampened by an August consumer-price index data that investors are anticipating on Thursday.
A rate cut by the Fed next Wednesday is currently viewed as having a 100% chance, especially in light of the unexpected drop in August producer prices and the worsening of U.S. job growth. Now, the only issues are how much this rate drop will be and what policymakers would say about more reductions this year if the CPI report tomorrow is more aggressive than anticipated. In the meanwhile, some of the impact of the Trump administration’s trade policy is being mitigated by businesses, who are bearing a portion of the tariff expenses.
After accounting for a 0.3% monthly gain from the previous month, economists predict that the annual headline CPI rate will gradually increase from 2.7% in July to 2.9% in August. It is anticipated that core readings, which exclude food and energy, will stay constant at 3.1% annually and 0.3% monthly. It would take a “very large” upside surprise, according to Russell Investments senior strategist BeiChen Lin, to prevent Fed officials from cutting rates by 25 basis points next week, but a slight surprise could be sufficient to convince them to do so by sending a message of concern about the risks of future price gains.
One category that may surprise traders and investors is core services, which is included in the CPI report’s details. This category, which does not include energy services but does include housing, transportation, and medical services, is meant to provide a more steady picture of the underlying trends in inflation.
There is currently a chance that the annualized run rate of core services will increase more quickly than it did earlier this year. Omair Sharif, founder of the research and analytical business Inflation Insights, said it generated an annualized run rate of 2.4% and averaged 0.2% from February to May. The annualized run rate would rise to 3.6% if it came in at 0.3% for August, which would result in a three-month average of 0.3% since June, Sharif explained over the phone.
According to Jim Baird, chief investment officer of Michigan-based Plante Moran Financial Advisors, “There has been so much focus on tariffs and the inflation impact on goods that it may be easy to overlook the risk posed by core services inflation.”
The services sector “remains a significantly larger portion of the economy, is more closely linked to wage pressures, and makes up a larger portion of the consumer-price index.” “It has a significant impact on the overall inflation picture,” Baird stated over the phone. “If we get a stronger reading than is expected on inflation generally, or core services in particular, it may cause investors to recalibrate their expectations about how aggressively the Fed will be able to ease after September.” He went on to say that the market’s initial response would probably be “negative,” with some volatility possible as investors process the information and reconsider its implications for interest rates.
The Dow Jones Industrial Average DJIA, the S&P 500 SPX, and the Nasdaq Composite COMP all reached record closing highs on Tuesday as a result of stock investors’ expectations that the Federal Reserve will lower interest rates starting next week and continuing through year-end. Despite last week’s announcement of only 22,000 nonfarm-payroll jobs added for August and this week’s downward estimate of 911,000 nonfarm-payroll jobs for the 12-month period ending in March, the S&P 500 and Nasdaq were primed for more gains as of Wednesday afternoon.
Paul Stanley, chief investment officer at Granite Bay Wealth Management, a New Hampshire-based firm that manages about $450 million in assets, stated that stock market investors have “just gotten very good recently at brushing off these inflationary concerns, because policy has been changing so regularly that when you look at a one-time or a short-term uptick in the core CPI, the thought process is, ‘We’re not going to worry about it, because things are changing so fast.’…”
In theory, a weakening labor market tends to result in less demand from consumers, which should lower inflation. However, there have been concerns that the United States may be dealing with both growing inflation and stalling growth, the latter of which could be harder to eradicate if the central bank lowers interest rates on Wednesday. Inflation traders do not anticipate a sustained decline in the annual headline CPI rate, but if Thursday’s data is cooler than anticipated, the likelihood of a larger-than-expected 50-basis-point Fed rate decrease next week may increase.
Even when Wednesday’s data revealed an unexpected drop in producer prices for August, these traders remained steadfast in their predictions regarding the trajectory of CPI inflation into the following year. They are forecasting an annual headline CPI rate of 2.9% for August on Thursday, which is in line with the consensus estimate of experts. However, through next July, the rate will rise back up to between 3.1% and 3.4%.
In an email to MarketWatch, David Adams, head of Morgan Stanley’s G10 foreign-exchange strategy, stated that “the composition and context matter more than the level of CPI growth.” “Increasing evidence of tariff pass through for both goods and services could make investors more worried about inflation persistence.”
Given investors’ mounting labor market concerns, Adams stated that any increase in the value of the US dollar after a CPI inflation number that is larger than anticipated “should be faded,” according to the currency market. According to him, market participants would probably price in even greater rate cuts for 2026 if the rate-setting Federal Open Market Committee decided to lower rates less in 2025 due to inflation concerns.
The 3.1% consensus estimate for the year-over-year core CPI rate is still alarming and provides little indication of lowering inflation, according to Hunter Hayes, chief investment officer at Florida-based investment firm Intrepid Capital. Additionally, he stated that while a print close to 3% would appear reasonable on its own, it accumulates far more quickly than 2% and will eventually have a major effect on the US economy.
“It’s going to continue to exacerbate this unaffordability crisis for a lot of consumers,” he said telephonically on Wednesday to BourseWatch. nevertheless, “whatever the CPI number is tomorrow, it will be framed and used by investors as an excuse to get the rate cuts that seem inevitable at this point for next week.”
