'US 3-Year Expected Inflation Hits Record Low...Will September Big Cut Gain Momentum Again? (Comprehensive)'

U.S. consumers' expected inflation rate over the next three years has fallen to a historic low of 2.3%. This suggests that consumer concerns about inflation have significantly eased at a time when the Federal Reserve's (Fed) monetary policy pivot is anticipated in September. The key question is whether this outlook will be confirmed in the consumer price index (CPI) and producer price index (PPI) data to be released this week. Currently, market expectations for a so-called ‘big cut’?a 0.5 percentage point rate cut at once?have somewhat diminished as recession fears have partially eased, but if these indicators show a significant slowdown, the big cut scenario could regain momentum.

According to the July consumer outlook survey released on the 12th (local time) by the New York Federal Reserve Bank, the median expected inflation rate three years ahead, which reflects medium-term inflation expectations, stood at 2.3%. This is the lowest level since the survey began in June 2013 and represents a sharp 0.6 percentage point drop from the previous month. The one-year ahead expected inflation rate was 3.0%, and the five-year ahead rate was 2.8%, both unchanged from the previous month.

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Notably, this survey result drew attention amid recent widespread recession fears that have unsettled financial markets and increased uncertainty around September’s monetary policy. Expected inflation is a key economic indicator closely watched by the market because it influences pricing decisions for various goods and services, wage increase demands, and is reflected in actual inflation. Economic media outlet CNBC explained, "Consumers expect inflation to remain high next year but ease within 2 to 3 years," adding that "this strengthens confidence that inflation will not be a major problem in the coming years."

Market focus now turns to economic data releases this week, which could provide clearer hints about the Fed’s rate cut magnitude in September. Following the expected inflation data, the PPI, a wholesale price index, will be released on the 13th, and the CPI on the 14th. If these indicators show a sharper slowdown than expected, calls for a significant rate cut at the September Federal Open Market Committee (FOMC) meeting are likely to gain strength.

Wall Street expects the July CPI inflation rate to be 3.0% year-over-year and 0.2% month-over-month. The core CPI, which excludes volatile energy and food prices, is forecasted to rise 3.2% year-over-year, slightly down from 3.3% the previous month. Although the Fed’s inflation target of 2% is still some way off, inflation concerns have eased to about one-third of what they were two years ago.

Earlier, recession fears had rapidly increased expectations for a big cut in September, but these concerns have somewhat eased amid counterarguments that the worries were excessive. According to the Chicago Mercantile Exchange (CME) FedWatch tool, the federal funds (FF) futures market currently prices a 50% chance each for a 0.25 percentage point and a 0.5 percentage point rate cut in September. This is a notable decline from the 80%+ odds for a big cut seen shortly after the employment shock heightened recession fears.

The reasons behind this moderation include signals from additional employment data confirming that the labor market remains resilient, and cautious rate-setting stances confirmed by Fed officials. Bloomberg reported, "This week marks the U.S.’s ‘inflation week’ with major inflation indicators being released, but everyone is talking about jobs," noting that both financial markets and monetary policy outlooks have shown high volatility recently depending on employment data. However, the fact that the futures market still prices a 50% chance of a big cut indicates that investors still consider the big cut option a major possibility after the CPI release.

In contrast to the optimistic inflation outlook, the New York Fed’s consumer survey also revealed concerns about household debt and consumer spending. Americans’ expected increase in consumer spending over the next year dropped to 4.9%, down 0.2 percentage points from the previous month, marking the lowest level since April 2021 when inflation concerns became prominent. The delinquency rate forecast for failing to pay even the minimum amount over the next three months was the highest since April 2020. FX Leaders noted, "Unlike inflation expectations, concerns are growing in other areas such as household finances and credit accessibility."

The July retail sales data, which reflects U.S. consumer spending, is also scheduled for release this week. Some on Wall Street analyze that Americans are already experiencing a so-called ‘vibe session’?a situation where they feel the economy has entered a recession due to high inflation and living cost burdens.

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