Economists Foresee US Inflation Moderation in September Despite Elevated Oil Prices

What happened

Economists are projecting that the U.S. Consumer Price Index (CPI) report, due for release on Wednesday, will show moderation in key inflation metrics for September. This expectation comes even as oil prices remain elevated, above $90 per barrel. For September, the headline inflation growth is projected to be 0.5% month-over-month and 3.6%-3.7% year-over-year. These figures represent a slight increase from August, which saw 0.4% m-o-m and 3.4% Y/Y. However, core CPI, which excludes volatile energy and food prices, is expected to climb 0.2% in September, a deceleration from the previous month.

Why it matters

The anticipated moderation in inflation, particularly in core CPI, is a critical factor for the Federal Reserve's (Fed) monetary policy. If inflation continues to show signs of cooling, even with pressure from oil prices, it could provide the Fed with more flexibility to slow the pace of its interest rate hikes or even signal a future pause. The economy's ability to absorb commodity price shocks without widespread inflationary acceleration is a positive sign of resilience and indicates that previous monetary tightening measures are taking effect. A less aggressive monetary policy tends to be favorable for economic growth and risk assets.

Market impact

• Interest rates and bonds: The expectation of inflation moderation tends to reduce pressure on the Fed for aggressive rate hikes. This could lead to a decline in longer-term Treasury yields, as the market prices in a scenario of less monetary tightening and more controlled inflation. Fixed-income securities tend to appreciate in this scenario.
• Dollar and exchange rates: A less 'hawkish' Fed (inclined to raise rates) could weaken the dollar against other currencies. If the expected interest rate differentials between the U.S. and other economies narrow, the dollar might lose some of its safe-haven appeal, benefiting emerging market currencies.
• Equities: The prospect of more stable or decelerating interest rates is generally positive for stock markets. Lower borrowing costs and a less restrictive economic environment tend to boost corporate earnings and demand for risk assets, favoring the equity market.
• Brazil: A global scenario of more controlled inflation in the U.S. and a less aggressive Fed tends to be beneficial for Brazil. This could ease pressure on the exchange rate, allowing the real to strengthen, and may also open space for the Copom to consider more significant Selic rate cuts, boosting economic activity and the Brazilian stock market.

What to watch

The main event to watch is the release of the U.S. CPI report on Wednesday. Investors will be paying close attention not only to the headline inflation figures but, crucially, to the core CPI data, which is considered a more accurate indicator of underlying inflationary pressures. Any significant deviation from expectations could alter projections for Fed policy and consequently impact markets.

Scenarios

Base Case: Consumer inflation (core CPI) decelerates as expected, giving the Fed more room for a less aggressive stance. This would result in lower Treasury yields, a weaker dollar, and higher equities. Risk Scenario: Inflation surprises to the upside, indicating that price pressures are more persistent than anticipated. This would force the Fed to maintain a 'hawkish' stance, pushing Treasury yields higher, strengthening the dollar, and putting pressure on equities.

Original source: OilPrice.com. For information only, not investment advice.