Wall Street now sees 3 Fed rate cuts before year-end

The July Consumer Price Index (CPI) report showed a headline increase of 2.7% year-over-year, slightly below the 2.8% estimate, significantly boosting U.S. stock futures and intensifying market expectations for Federal Reserve rate cuts. The probability of a September cut rose to 91.8%, with increased chances for multiple cuts by year-end. However, the core CPI, excluding food and energy, rose 3.1% year-over-year, slightly exceeding the 3.0% consensus, indicating some persistent inflationary pressures despite the overall dovish market interpretation.

Analysis

The July CPI report delivered a nuanced but ultimately bullish signal for markets, primarily driven by the headline inflation figure. The headline consumer price index rose 2.7% year-over-year, slightly below the 2.8% consensus estimate, which immediately fueled a risk-on sentiment and intensified expectations for Federal Reserve easing. This market reaction was quantifiable, with stock futures surging and CME FedWatch tool probabilities for a September rate cut rising to 91.8%, alongside a 56.7% chance of three cuts by year-end. However, the report was not unequivocally positive, as core CPI, which strips out food and energy, accelerated to 3.1% YoY, exceeding the 3.0% forecast. While most strategists believe this print provides the Fed with sufficient cover for a September "insurance cut," citing transitory tariff effects, a minority view highlights that the sticky core reading well above the 2% target complicates the Fed's path and represents a notable risk to the dovish narrative.

Key Decisions for Investors

• Given the market's strong positive reaction and heightened expectations for multiple Fed rate cuts, investors may consider maintaining exposure to risk assets as the data provides a near-term catalyst for upward momentum.
• Closely monitor upcoming core inflation reports and corporate commentary on tariff impacts, as the elevated 3.1% core CPI reading represents a key risk that could challenge the narrative of sustained Fed easing if inflationary pressures persist.
• With the market now largely pricing in a September cut, consider that the unwinding of hedges may lead to lower volatility in the short-term, supporting a 'buy the dip' strategy as suggested by several analysts in the event of any pullbacks.