Stock investors were met with disappointing news as August inflation numbers showed a rise in core inflation, dashing hopes for a larger rate cut from the Federal Reserve. The stock market reacted swiftly to the news, with US indexes dropping significantly on Wednesday.
The consumer price index for August indicated a 2.5% increase in prices on a yearly basis, the lowest headline inflation rate recorded since early 2021. However, core inflation, which excludes volatile food and energy prices, rose unexpectedly by 0.3% for the month, surpassing the estimated 0.2% increase.
The unexpected rise in core inflation has led investors to reassess their expectations for the Fed's next policy meeting. Previously, there were hopes for a 50 basis-point rate cut, but now markets are pricing in an 83% chance of a 25 basis-point cut.
Julian Howard, the chief multi-asset investment strategist at GAM Investments, noted that core and services inflation appeared to be resilient in the latest figures. This unexpected increase in inflation has made a larger rate cut by the Fed less likely, as it cannot solely base its decisions on a weakening labor market.
While investors may be disappointed by the prospect of a smaller rate cut, analysts have pointed out that a 50 basis-point cut could have signaled concerns about a significant economic slowdown. Cutting rates by just 25 basis points means that interest rates will stay higher for longer.
Moving forward, investors will closely monitor job market data for signs of further weakness. The upcoming jobless claims report will be a key factor ahead of the Fed meeting next week.
Despite the revised expectations for the Fed's rate cut, markets are still anticipating moderate rate cuts by the end of the year. There is an 84% chance that the Fed will cut rates by 100 basis points or more by December, depending on future economic data.
Overall, the unexpected rise in core inflation has led to a reassessment of market expectations and a shift in investor sentiment as they prepare for potential rate cuts and monitor economic indicators closely.