Economics
Wednesday’s CPI report could mark a change in thinking for the Fed
Product prices as seen at Walmart.
Courtesy: Walmart
The news Tuesday was good for inflation, and investors hope it will get even better Wednesday when the Labor Department releases the July consumer price index report.
With the score being one down, one to go on confirming that the early-year jump in prices either was a fluke or the last gasp of inflation, a positive CPI reading could mean the Federal Reserve is able to turn its gaze to other economic challenges, such as the slowing labor market.
“At this point, the inflationary pressure that we saw build has really been dissipated significantly,” said Jim Baird, chief investment officer at Plante Moran Financial Advisors. “Inflation is almost a nonissue at this point. There’s this broad expectation that the worst is easily behind us.”
Like others on Wall Street, Baird expects the Fed in September to shift its focus from tight policy to tackle inflation to a somewhat easier stance to head off a potential weakening in the jobs picture.
While consumers and business owners continue to express concern over high prices, the trend indeed has shifted. Tuesday’s producer price index (PPI) report for July helped confirm optimism that the elevated inflation numbers that began in 2021 and spiked again in early 2024 are in the rearview mirror.
The PPI report, seen as a gauge of wholesale inflation, showed prices up just 0.2% in July and about 2.2% from a year ago. That number is now very close to the Fed’s 2% goal and indicative that the market’s impulse for the central bank to start cutting rates is about on target.
Economists surveyed by Dow Jones expect the CPI similarly to show 0.2% increases on both the all-items reading and the core measurement that excludes food and energy. However, that is projected to show respective 12-month rates of 3% and 3.2% — well below their mid-2022 highs but still a good distance from the Fed’s 2% target.
Still, investors are looking for the Fed at its September meeting to start cutting interest rates, considering that inflation is weakening and so is the labor market. The unemployment rate has now risen to 4.3%, a 0.8 percentage point increase over the past year that has triggered a time-tested recession flag known as the Sahm Rule.
“Given the focus on the relative weakening in the labor market, given the fact inflation is coming down pretty rapidly, and I expect it will continue over the next few months, it would be a surprise if the Fed didn’t start moving towards easing very quickly, presumably at the September meeting,” Baird said. “If they don’t at the September meeting, the market is not going to take kindly to that.”
Worries over slow Fed response
A brief pickup in weekly initial unemployment claims, combined with other weakening economic metrics, briefly had some in the market looking for an emergency rate cut.
While that sentiment has dissipated, there’s still worry about the Fed being slow to ease, just as it was slow to tighten when inflation began to escalate.
Another benign inflation report “makes the Fed completely comfortable that they can shift their focus away from inflation and toward labor,” said Tom Porcelli, chief U.S. economist at PGIM Fixed Income. “They could have shifted their attention from inflation to labor … months ago. There are cracks forming in the labor market backdrop.”
Amid the twin realities of declining inflation and rising unemployment, markets are pricing in the absolutely certainty of a rate cut at the Sept. 17-18 Fed meeting, with the only question left being how much. Futures pricing is roughly split between a quarter- or half-point reduction, and leaning heavily to the likelihood of a full percentage point reduction by the end of the year, according to CME Group calculations.
However, futures pricing has been well off the mark for most of the year. Traders started the year anticipating a rapid pace of cuts, then pulled back into expecting only one or two before the latest swing in the other direction.
“I’m as curious about [Wednesday’s] inflation report as anyone else, but I think it would take a real outlier to change the Fed’s tune from 1) shifting to labor as its focus, and 2) seriously thinking about cutting in September,” Porcelli said. “They should start off aggressively. I can easily make the argument for the Fed to cut 50 basis points just to kick things off because I think they should have been cutting already. I don’t think that’s what they will do. They’ll start it off modestly.”
Production at the VW plant in Emden.
Sina Schuldt | Picture Alliance | Getty Images
The struggling German economy has been a major talking point among critics of Chancellor Olaf Scholz’ government during the latest election campaign — but analysts warn a new leadership might not turn these tides.
As voters prepare to head to the polls, it is now all but certain that Germany will soon have a new chancellor. The Christian Democratic Union’s Friedrich Merz is the firm favorite.
Merz has not shied away from blasting Scholz’s economic policies and from linking them to the lackluster state of Europe’s largest economy. He argues that a government under his leadership would give the economy the boost it needs.
Experts speaking to CNBC were less sure.
“There is a high risk that Germany will get a refurbished economic model after the elections, but not a brand new model that makes the competition jealous,” Carsten Brzeski, global head of macro at ING, told CNBC.
The CDU/CSU economic agenda
The CDU, which on a federal level ties up with regional sister party the Christian Social Union, is running on a “typical economic conservative program,” Brzeski said.
It includes income and corporate tax cuts, fewer subsidies and less bureaucracy, changes to social benefits, deregulation, support for innovation, start-ups and artificial intelligence and boosting investment among other policies, according to CDU/CSU campaigners.
“The weak parts of the positions are that the CDU/CSU is not very precise on how it wants to increase investments in infrastructure, digitalization and education. The intention is there, but the details are not,” Brzeski said, noting that the union appears to be aiming to revive Germany’s economic model without fully overhauling it.
“It is still a reform program which pretends that change can happen without pain,” he said.
Geraldine Dany-Knedlik, head of forecasting at research institute DIW Berlin, noted that the CDU is also looking to reach gross domestic product growth of around 2% again through its fiscal and economic program called “Agenda 2030.”
But reaching such levels of economic expansion in Germany “seems unrealistic,” not just temporarily, but also in the long run, she told CNBC.
Germany’s GDP declined in both 2023 and 2024. Recent quarterly growth readings have also been teetering on the verge of a technical recession, which has so far been narrowly avoided. The German economy shrank by 0.2% in the fourth quarter, compared with the previous three-month stretch, according to the latest reading.
Europe’s largest economy faces pressure in key industries like the auto sector, issues with infrastructure like the country’s rail network and a housebuilding crisis.
Dany-Knedlik also flagged the so-called debt brake, a long-standing fiscal rule that is enshrined in Germany’s constitution, which limits the size of the structural budget deficit and how much debt the government can take on.
Whether or not the clause should be overhauled has been a big part of the fiscal debate ahead of the election. While the CDU ideally does not want to change the debt brake, Merz has said that he may be open to some reform.
“To increase growth prospects substantially without increasing debt also seems rather unlikely,” DIW’s Dany-Knedlik said, adding that, if public investments were to rise within the limits of the debt brake, significant tax increases would be unavoidable.
“Taking into account that a 2 Percent growth target is to be reached within a 4 year legislation period, the Agenda 2030 in combination with conservatives attitude towards the debt break to me reads more of a wish list than a straight forward economic growth program,” she said.
Franziska Palmas, senior Europe economist at Capital Economics, sees some benefits to the plans of the CDU-CSU union, saying they would likely “be positive” for the economy, but warning that the resulting boost would be small.
“Tax cuts would support consumer spending and private investment, but weak sentiment means consumers may save a significant share of their additional after-tax income and firms may be reluctant to invest,” she told CNBC.
Palmas nevertheless pointed out that not everyone would come away a winner from the new policies. Income tax cuts would benefit middle- and higher-income households more than those with a lower income, who would also be affected by potential reductions of social benefits.
Coalition talks ahead
Following the Sunday election, the CDU/CSU will almost certainly be left to find a coalition partner to form a majority government, with the Social Democratic Party or the Green party emerging as the likeliest candidates.
The parties will need to broker a coalition agreement outlining their joint goals, including on the economy — which could prove to be a difficult undertaking, Capital Economics’ Palmas said.
“The CDU and the SPD and Greens have significantly different economic policy positions,” she said, pointing to discrepancies over taxes and regulation. While the CDU/CSU want to reduce both items, the SPD and Greens seek to raise taxes and oppose deregulation in at least some areas, Palmas explained.
The group is nevertheless likely to hold the power in any potential negotiations as it will likely have their choice between partnering with the SPD or Greens.
“Accordingly, we suspect that the coalition agreement will include most of the CDU’s main economic proposals,” she said.
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