US CPI and ECB meeting to dominate

We are reaching the apex of the week, US CPI and to a lesser extent the ECB meeting, will determine the direction of markets in the short term. As we lead up to these key events, the dollar is mixed, market enthusiasm for stocks remains high, the S&P 500 made a fresh record on Wednesday, and futures suggest that the US and European  stocks could open slightly higher later today.  

Why CPI is unlikely to derail Fed rate cut hopes

US CPI will be watched closely to see if inflation can override concerns about the labour market. The stock market juggernaut continues, as demand for stocks is underpinned by expectations of multiple rate cuts. Although there are some concerns that a stronger CPI reading could derail hopes for Fed rate cuts, we think that the chances of a major recalibration of Fed rate cut expectations is unlikely after this report.

Producer prices ease market fears about CPI

The market expects a jump in CPI  to 2.9% from 2.7% in July. However, a weaker producer prices report has eased some fears about price increases in the US. This report was key for analysts and investors since it was one of the first inflation readings that we could see the pass through from the effects of tariffs. However, a negative monthly PPI print for August has eased fears that tariff-related inflation could impact the pace of Federal Reserve rate cuts.

Digging deeper into the producer price data saw negative energy prices, and lower services prices, while food and core PPI prices were stable. There was a large decline in trade services prices, which is a sign that producers, for now, are willing to absorb tariff related price increases. It seems likely that tariff related inflation is coming, though it may take many months for it to feed through to the data, especially if producers, at the top of the CPI pipeline, are not passing on price increases.

Tarriff shadow cast over inflation report

US CPI is set to rise today, driven by higher gasoline prices and increases in food prices. Coffee prices are expected to surge on the back of US tariffs, and beef prices are also expected to rise. There has been a slow response to tariffs from CPI, which is partly down to inventories: businesses are selling goods that were imported before export restrictions became live.

Whether or not we see pass through from tariff costs to consumer goods, could depend on demand. If consumer demand remains strong, then retailers may feel more confident in rising prices. However, a lower-than-expected CPI report later today could also be a signal that consumer demand is faltering in the US.

Tariffs are only one part of the upward pressure on prices. The crackdown on immigration is impacting farming and is one reason why food prices are rising. However, since volatile elements of inflation, including energy and food prices are driving the CPI report higher, we think that the Fed could look through this inflation report and it will not deter them from slashing US interest rates in the coming months.

Trump gets his way on rate cuts

In the aftermath of the PPI report, Donald Trump posted triumphantly that there is ‘No Inflation’, and ‘Too late’, aka Jerome Powell, needs to lower interest rates straight away. Trump is expected to get his way, although he may have to wait a week for a rate cut. The market is fully pricing in a 25bp rate cut, and there is an 8% chance of a larger 50bp move. A weaker than expected CPI print could see expectations for a 50bp cut soar.

There is a high probability of three rate cuts between now and the end of the year, with 6 rate cuts priced in by January 2027. The close link between rate cuts and stocks means that any surprise reading in CPI later today could trigger a big move in stocks. However, the options market is pricing in further gains for the S&P 500 after this report.

The impact of CPI on stocks

On balance the S&P 500 tends to fall in the hour after a CPI release, but the move is mild. However, after the July CPI report was released last month, the index rose by 0.25%, as inflation remained steady at 2.7%. Over the past year, US stock market gains have not been deterred by slight upticks in the CPI report.

ECB: Set to remain neutral as rate cutting cycle nears end

The ECB meeting is also in focus today, and no change is expected. The interest rate futures market is pricing in less than one full cut between now and the middle of next year. This suggests that 2%, the current ECB interest rate, could be the long term neutral rate for the Eurozone, and we could be at the end of the ECB rate cutting cycle.

Doves silenced, for now

Stronger economic data, along with a more upbeat tone from ECB members, has been enough to silence ECB doves for now. The ECB staff economic forecasts will also be released today, including GDP and CPI forecasts.  The 2025 GDP forecast could be revised higher, while the outlook for 2026 and beyond is complicated by a higher-than-expected tariff rate, which could weigh on future projections.

The ECB is likely to show slight concern about the stickiness of core prices, especially service inflation, and core prices remain above the ECB’s target rate, after service prices rose to 3.1% last month.

Euro and bond yields in focus

The ECB will need to tread carefully. If Christine Lagarde signals that interest rates have bottomed, then we could see the euro surge back to 2025 highs above $1.18. EUR/USD is already 13% higher YTD vs. the USD, which is adding pressure to exporters. Thus, we do not expect Lagarde to shift to a hawkish message, and we expect her to dwell on downside risks to growth, including tariffs, and French political turmoil.

The collapse of the French government has not spooked financial markets this week, and French bond yields have remained stable. The ECB will be careful not to say anything that could cause a surge in yields and exacerbate French fiscal problems further. Thus, a neutral stance from the ECB, which gives nothing away regarding future rate cuts, could be on the cards.