The market is "too certain" about the Federal Reserve's rate cut in September, Morgan Stanley: Future data is very important, especially the US CPI
The market's expectations for a rate cut by the Federal Reserve in September are overly certain. Morgan Stanley's chief economist, Seth Carpenter, pointed out that future economic data, especially the CPI, will be crucial for decision-making. Despite poor signals from the labor market, inflationary pressures are rising, with tariffs being a major driver, and their effects have a lag period of 3 to 5 months. The June CPI has already shown initial signs of tariff-driven inflation, and future data will determine the Fed's policy direction
The downward revision of the U.S. non-farm data for May and June has changed the narrative around the U.S. economy, with the interest rate market collectively shifting to focus on downside risks, now viewing a rate cut in September as almost certain.
According to news from the Wind Trading Desk, Morgan Stanley's Chief Global Economist Seth Carpenter stated in his latest report that while the market currently sees the Federal Reserve's rate cut in September as nearly certain, there are still many variables to observe.
The report pointed out that statements from Federal Reserve Chairman Jerome Powell at the press conference and comments from New York Fed President John Williams after the non-farm data release indicate that the upcoming economic data will still be crucial for the decision-making in the September meeting.
This week's CPI data will be particularly important, especially in addressing how tariffs drive inflation outcomes. The report emphasized that experience from 2018 shows that the full impact of tariffs typically requires a lag of 3 to 5 months, and the July CPI will clearly reveal the onset of tariff-driven inflation.
Lag in Tariff Transmission Effects
Despite red flags in the labor market, inflationary pressures are quietly building, which has become a core argument against rate cuts.
The report believes that tariffs are a major driver of inflation, and their effects exhibit a significant lag. Currently, the CPI for June has begun to show signs of tariff-driven inflation. Referring to the experience of 2018, the complete effect of tariffs transmitted to final consumer prices usually takes three to five months.
This lag is due to the realities of supply chain operations.
For example, the "effective tariff rate" calculated from actual tariffs collected and import amounts is significantly lower than the officially announced rates. Data shows that the effective rate for June was 8.9%, far below the announced rate of over 15%.
The report explains that this discrepancy arises from factors such as the timing of tariff implementation, transportation cycles, trade shifts, and compliance with the United States-Mexico-Canada Agreement (USMCA). Over time, this gap will gradually narrow, leading to sustained upward pressure on inflation in the coming months.
Additionally, companies, especially in the automotive industry, seem to have delayed price increases through inventory management, waiting to adjust prices after a new batch of higher-cost inventory arrives, which has also postponed the manifestation of inflation.
Inflation Pressure Expected to Persist, Data "Determines Success or Failure"
Looking ahead, the Federal Reserve's decision in September will be a difficult balance between "slowing employment" and "rising inflation."
On one hand, employment reports indicate a softening labor market; on the other hand, price increases seem to be a prevailing trend. Complicating matters further, the details of trade agreements have not yet been fully finalized, and this ongoing uncertainty itself can impact corporate hiring decisions.
Therefore, every piece of economic data before the September FOMC meeting will be closely watched by the market.
The U.S. CPI released this Tuesday will be the first key test. The report expects that the core CPI for July will accelerate from 0.23% to 0.32% year-on-year, primarily driven by core goods prices affected by tariffs. Before the September meeting, the market will also welcome an employment report and another CPI report. The report emphasizes that tariffs may simultaneously affect both data, which means the decision-making environment faced by the Federal Reserve may be more complex and nuanced than it is currently.
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