Overnight, the U.S. August CPI paves the way for the Federal Reserve to cut interest rates

A mild inflation report combined with signals of a weak labor market has cleared the way for the Federal Reserve to begin a rate-cutting cycle.

According to data released on Thursday, the U.S. August CPI rose 2.9% year-on-year, in line with expectations, and slightly up from the previous value of 2.7%. The U.S. August CPI increased 0.4% month-on-month, slightly above the expected 0.3%, with the previous value at 0.2%. The U.S. August core CPI rose 3.1% year-on-year and 0.3% month-on-month, both in line with expectations and previous values.

The data did not show the runaway inflation concerns previously feared by the market due to tariff measures, leading to a decline in Bloomberg Macro Inflation Surprise Index. Meanwhile, an unexpected surge in initial jobless claims for the week painted a picture of cooling inflation and slowing employment.

According to the Wind Trading Desk, Citigroup analysts believe that the details of this inflation report are "encouraging" for Federal Reserve officials preparing to implement a series of rate cuts.

The bank pointed out in the report that the price increases in the data are mainly driven by volatile factors that are unlikely to persist, and it expects the Fed's preferred inflation measure—the core Personal Consumption Expenditures (PCE) price index—to show more moderate growth, providing support for a rate cut announcement at next week's FOMC meeting.

Citigroup analysts Veronica Clark and Andrew Hollenhorst expect that the Federal Reserve will initiate a round of rate cuts, cumulatively lowering rates by 125 basis points over the next five FOMC meetings, with the policy rate potentially falling below 3%.

Mild CPI, soaring rate cut expectations

As a result of the data, traders significantly increased their bets on the Federal Reserve cutting rates in 2025, with the likelihood of a rate cut in October "soaring," leading to a "dovish frenzy" across various assets.

The U.S. dollar index fell, and the three major U.S. stock indices all closed at record highs, with the Dow Jones Industrial Average closing above 46,000 points for the first time. Safe-haven assets were also in demand, with gold prices reaching a new all-time high adjusted for inflation:

Stock Market: The U.S. stock market surged significantly, driven by short covering. The Dow Jones Industrial Average, S&P 500, and Nasdaq Composite all closed at historical highs, with the Dow breaking the 46,000-point mark for the first time. Small-cap stocks and the Dow performed particularly well.

Bond Market: The bond market was in demand, with yields falling across the board, and long-term bonds outperforming short-term ones (the 30-year Treasury yield fell by 4 basis points, while the 2-year yield fell by 1 basis point). The key 10-year U.S. Treasury yield briefly fell below 4.00% for the first time since April The 30-year mortgage rate has also fallen to its lowest level since February 2023.

Commodities and Forex: The US dollar index is under downward pressure. Gold prices have surged significantly, breaking through the historical high of January 1980, setting a new record adjusted for inflation. Crude oil prices have declined.

Cryptocurrency: Bitcoin continues to rise, returning above $114,000, reaching a three-week high. Ethereum outperformed Bitcoin.

Commodity price pressure is mild, limited tariff transmission effect

According to Citigroup, a deep analysis of the inflation data from August reveals that the upward momentum of commodity prices is weaker than expected, especially the much-watched tariff transmission effect seems to be very limited.

Data shows that core commodity prices rose 0.28% month-on-month, lower than Citigroup's expectations. Among them, furniture prices rose only moderately by 0.1%, entertainment goods prices remained flat, while medical goods prices fell by 0.3%. Although clothing prices increased by 0.5%, and new and used car prices rose by 0.28% and 1% respectively, Citigroup believes that the rise in car prices aligns with the "residual seasonality" pattern of price increases at the end of the year.

Citigroup's report particularly notes that considering autumn is usually a more natural time for businesses to pass on costs, as of August, the degree of tariff transmission to consumer goods prices "seems to be very limited," which is noteworthy. Additionally, based on the differences in weight among different commodity categories in core PCE, Citigroup expects the commodity price component in core PCE to record a decline.

Service sector inflation is differentiated, significant impact from one-time factors

In the service sector, the upward price momentum is mainly concentrated in a few volatile items, Citigroup believes that the impact of these factors may not be sustained.

Core service prices rose 0.35% month-on-month in August, with a significant portion of the increase coming from a 5.9% surge in airfare prices. Citigroup analysts believe this surge "is unlikely to be repeated" and will not be fully reflected in the core PCE data.

After an extraordinary decline in airfare prices in the first half of the year, there has been an abnormal rebound in recent months, which is also related to residual seasonality. Hotel prices have also rebounded after several months of decline. Overall, Citigroup expects weak demand for non-essential services to limit the annual upward space for these prices.

The performance of other service items also confirms the mild inflation pressure. For example, dental service prices, which surged significantly in June and July, fell by 0.7% in August, confirming the previous increase was a "one-time" event. Meanwhile, car rental service prices plummeted by 6.9%, and entertainment service prices also fell by 0.2%.

Housing inflation data appears robust, but the trend may be hard to sustain

The only detail in the August CPI data that may raise concerns is the 0.38% month-on-month increase in Owner's Equivalent Rent (OER), slightly stronger than expected. However, analysts believe this does not indicate a new upward trend Citigroup explained in the report that the rise in OER is primarily driven by "abnormally large increases" in small cities in the South, a situation that "may not be repeated." They emphasized that given the continued weakness in new lease data in recent months and the decline in housing prices, there should be no concern over the slightly strong OER data for a single month.

The bank expects that during the remainder of 2025 and into 2026, owner equivalent rent will continue to show a slowing trend, thereby alleviating overall inflationary pressures.

Overall, the CPI report for August and its details provide more justification for the Federal Reserve to initiate interest rate cuts. With complete data on inflation and the labor market, market expectations for a rate cut at next week's FOMC meeting have become quite solid.

Citigroup's research report concludes that the moderate inflationary trend supports their core view that the Federal Reserve will soon begin a loosening cycle. The report reiterates its forecast: a 25 basis point rate cut next week, followed by a series of rate cuts that could ultimately bring the policy rate below 3%. This indicates that, in the view of policymakers, inflation risks are diminishing, while the demand supporting economic growth has become more prominent