Fed starting to cut rates in September is back on table after softer CPI print

The Consumer Price Index (CPI) data for May showed a lower-than-expected increase, suggesting a potential shift in the Federal Reserve's interest rate policy in the coming months.

The core CPI, which excludes volatile food and energy prices, rose by 0.2% month-on-month and 3.4% over the past 12 months. The headline CPI, which includes all items, remained stable on a monthly basis and exhibited a 3.3% increase compared to the previous year.

The slight dip in inflation rates has caught the attention of market analysts, as the figures came in 0.1 percentage point (p.p.) below market consensus. The detailed numbers reveal an even finer margin, with the core CPI registering a 0.16% increase month-on-month, closely bordering a 0.1% rise.

In response to the CPI report, Evercore ISI economists noted the Federal Reserve might interpret this data as a sign of easing inflationary pressures.

According to the firm, the May figures could set the stage for a potential reduction in interest rates as early as September, provided that the trend continues in the upcoming months. However, the Fed would require more substantial evidence of sustained progress to proceed with a rate cut.

"We think Powell wants to cut when – but not before – it is responsible to do so and will be very encouraged by this print," Evercore ISI said.

Evercore ISI anticipates that the Federal Open Market Committee (FOMC) will subtly update its statement to reflect the recent inflation developments.

The firm expects the FOMC to replace the previous language concerning the "lack of further progress" on inflation with a more moderate acknowledgment of "some modest progress," while still describing inflation levels as "elevated."

The distribution of rate cut expectations among FOMC members is likely to show a divide, with about ten to eleven members leaning towards a baseline of two cuts, and a significant number of nine to ten members favoring fewer or no cuts at all.

This split reflects the recent nature of the CPI data, the need for further confirmation, and a cautious approach to managing market expectations.

In light of the latest CPI report, Federal Reserve Chair Jerome Powell is expected to maintain a balanced outlook during the press conference, the analysts added.