Wednesday’s inflation figure of 2.5% for August — the lowest rate since February 2021 — gives the Federal Reserve the go-ahead signal on cutting rates when it meets on Sept. 18, according to economists.

“All clear for launch,” Chris Zaccarelli, Chief Investment Officer for Independent Advisor Alliance, said on Wednesday.

“The Fed has the green light to cut 25 bps next week, given that the inflation report was in line with expectations.”

Observers may find the inflation rate for August disappointing since it doesn’t justify cutting rates by 50 basis points next week. However, most Fed members already expressed a desire to start lowering rates slowly instead of beginning with a jumbo cut, Zaccarelli said.

Inflation Takeaways

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Zaccarelli said the risks going forward are a slowing economy and a worsening labor market. The Fed priced in a 1% cut by the end of the year with only three meetings left in 2024. This implies that rates may get lowered by 0.5% at one of those meetings.

“But if the economy continues to slow — and not drop into an abrupt recession — the Fed will be able to cut at a measured, 25 bps-per-meeting pace,” he said.

The CPI report suggests that the Fed cut rates by 0.25% instead of a “hoped-for” 0.50% as inflation slowly heads toward the Fed’s 2% target, said Quincy Krosby, chief global strategist for LPL Financial.

“The reaction in the ten-year Treasury yield, as it inched higher, underscores that the bond market, where yields have been edging lower, agrees,” she said.

The yield on 10-year Treasuries advanced three basis points to 3.67% on Wednesday.

“Still, the climb lower in two- and 10-year Treasury yields reflected a deflationary tone,” Krosby said. “Today’s print should assuage markets that deflation caused by an economic scare has been avoided, at least for now.”

The falling inflation will allow the Fed to focus more on the employment mandate than its pricing stability mandate for the rest of the year, said Jeffrey Roach, chief economist for LPL Financial.

“Given the stickiness of services inflation, the Fed will likely cut by 25 basis points in the upcoming meeting and reserve the potential for more aggressive action later this year if we have further deterioration in the job market,” he said.

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