Wall Street sees September rate cut as sure thing — CPI inflation data may have a lot to say about what comes next

Markets are fully pricing a September Federal Reserve rate cut, with 100% probability, following weak August nonfarm payrolls data that showed just a 22,000 rise. However, upcoming inflation data, particularly the core CPI's services component, is crucial, as strategists warn that persistent services pressure or significant tariff-related price pass-through could temper expectations for further easing beyond initial cuts, despite some Fed officials remaining cautious. This dynamic suggests that while initial cuts may limit downside for equities, the trajectory of future policy remains highly sensitive to inflation readings, with the market currently pricing in 75 basis points of cuts by year-end.

Analysis

Market conviction for a September Federal Reserve rate cut is absolute, with fed-funds futures pricing a 100% probability following a starkly weak August jobs report showing only a 22,000 payroll increase and downward revisions to prior months. This has anchored expectations for at least 75 basis points in cuts by year-end. However, this positioning faces a critical test from upcoming August inflation data. While economists forecast a manageable 0.3% monthly rise in both headline and core CPI, the underlying composition is paramount. Strategists warn that a broadening of sticky services inflation, as opposed to soft goods prices, could significantly reduce the Federal Open Market Committee's appetite for signaling an extended easing cycle. This risk is compounded by uncertainty surrounding tariff pass-through, where an increase from the current 10-20% to 50% could push the Fed's preferred inflation gauge, PCE, above 3%—a full percentage point over its target. Although Fed Chair Powell has signaled a dovish tilt due to the labor market, officials like Chicago Fed President Goolsbee remain data-dependent and 'on the fence.' While the initial cut appears secured and is providing near-term support for equities, particularly the tech-heavy Nasdaq, the market's pricing for a deep cutting cycle remains vulnerable to an inflationary surprise.

Key Decisions for Investors

• Investors should scrutinize the upcoming core CPI report, focusing on the services inflation component, as persistent strength here could significantly temper market expectations for Fed easing beyond the anticipated September cut.
• Monitor incoming data and corporate commentary for evidence of higher tariff-related price pass-through, as a shift toward 50% could force a hawkish pivot from the Fed and challenge the current 'bad news is good news' market narrative.
• Given that markets are pricing in 75 basis points of cuts by year-end, a level some strategists consider overly ambitious, it may be prudent to assess portfolio sensitivity to a shallower-than-expected easing cycle.
• Note the recent outperformance of the tech-heavy Nasdaq over the Dow Jones Industrial Average, as this divergence highlights that rate-sensitive growth sectors are the primary beneficiaries of current easing expectations, a trend that could reverse if inflation proves unexpectedly resilient.