Sometimes there's no pleasing the markets, and this seems to be one of those times. Today the BLS reported that headline CPI rose 2.5 percent in August from a year ago -- down from 2.9 percent in July, below market expectations and the lowest reading since February 2021. At first blush that would seem to reinforce the possibility that the Fed will start its easing cycle with a 50 basis point cut later this month. But no: markets sold off heavily in the wake of the report, with the DJIA falling by as much as 700 points at one stage.
According to CNN, the seemingly perverse market reaction happened because investors chose not to look at the headline number, but rather to focus on core CPI, which posted a 0.3 percent month-on-month increase, to stand 3.2 percent higher than a year ago. Given the Fed's focus on core measures, that makes some sense. However, another possible explanation suggests itself. The sharp fall in the year-on-year headline number is largely the result of a favourable "base effect", as large gasoline price increases a year ago fell out of the calculation. Up here north of the border, where something similar has been observed, the Bank of Canada has been warning that such effects often prove transitory. A similar concern may well be appropriate for the US.
Prior to today's report, futures markets had been pricing in as much as a one-third possibility of a 50 basis point rate cut this month. That has now been hastily unwound, with a 25 basis point rate cut now seen as by far the likeliest outcome.
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