Wall Street Awaits CPI Data, Expecting Inflation but Limited Market Swings

Wall Street is gearing up for the release of the Consumer Price Index (CPI) report, with expectations of rising inflation. However, there's a prevailing sentiment that the robust labor market will remain the primary market driver, mitigating the likelihood of significant stock price fluctuations.

Modest Volatility Expected

According to Stuart Kaiser, head of U.S. equity trading strategy at Citi, options traders are pricing in modest volatility in the S&P 500 (SPX) following the CPI report, with a potential move of approximately 0.7% up or down. This is lower than the average actual volatility of 0.9% on CPI release days over the past year and also below the volatility expected ahead of the next jobs report on October 3rd. Kaiser believes that current implied volatility expectations are already elevated.

Focus on Fed Policy Path

This all ties into traders' expectations regarding the Federal Reserve's interest rate path. With U.S. jobs data showing signs of weakness "sufficient to threaten economic growth," the market anticipates the Fed to cut the federal funds rate by 25 basis points at the conclusion of the September meeting, and potentially continue cutting in October and December meetings. Wall Street is closely watching the Fed's thinking, with the market already pricing in interest rate cuts exceeding 1 percentage point over the next year. However, a hotter-than-expected inflation print could disrupt this path.

Potential Scenarios and Market Impact

"We do not think the CPI print poses a real risk of 'forcing the Fed to pause rate cuts in September,'" wrote Andrew Tyler, head of global market intelligence at J.P. Morgan, in a note to clients on Monday. "But we certainly think a meaningfully hawkish CPI print would alter the Fed's response to the October and December meetings." Several major banks have already raised their rate cut expectations, believing the Fed will cut rates more than previously predicted. For example, Barclays economists now expect three 25-basis-point cuts this year, and two more in 2026. This CPI report will serve as one of the "more clues to help U.S. traders decipher the Fed's rate path," enriching the larger picture of current economic data. Tyler wrote that if the report shows a significant rise in consumer prices, "then we may see inflation accelerate persistently through year-end and into 2026." He said that such an outcome could lead the Fed to pause rate cuts at the October and December meetings, especially if economic growth indicators like GDP continue to rise.

Economic Forecasts and Market Risks

Economists forecast that the core CPI, which excludes food and energy costs, will rise 0.3% month-over-month in August, with the year-over-year growth remaining steady at 3.1% — a level far above the Fed's 2% target and flat compared to the previous month. The "most probable scenario" presented by Tyler's team shows: core CPI rising 0.3% to 0.35%, and the S&P 500's fluctuation range will be between a decrease of 0.25% and an increase of 0.5%. Tyler wrote that if core CPI rises 0.25% to 0.3%, J.P. Morgan's trading desk expects the S&P 500 to rise 1% to 1.5%. If the monthly increase is below 0.25%, the S&P 500 may see a rebound of 1.25% to 1.75%. If the monthly increase of core CPI exceeds 0.4%, the S&P 500 will fall by up to 2% -- but he believes this scenario has only a 5% chance of happening.

Resilient Economic Growth and Market Impact

As economic growth remains resilient, traders believe risks in the coming weeks are low. The Atlanta Fed's GDPNow model shows that the real GDP annualized growth rate in the third quarter will reach 3%, slightly lower than the 3.3% in the second quarter, but still at a relatively strong level. This also explains why the Chicago Board Options Exchange Volatility Index (VIX) is far below the 20 level, which is the "key threshold at which traders begin to worry." At the same time, the Citigroup U.S. Economic Surprise Index—a rolling index that measures whether actual values ​​of economic indicators are higher or lower than expected—is near its highest level since January of this year. Typically, a rising economic surprise index is good for the stock market. But in the current environment, if there are more positive surprises in the economy, it could complicate the Fed's goal of "curbing inflation," forcing it to keep high interest rates for longer. "Everything will depend on the labor market," Citi's Kaiser said. "If the Fed cuts rates in October, it likely means that the jobs data is still under pressure and inflation has not risen unexpectedly."