What does the latest U.S. inflation report reveal?

Executive summary:

• The August consumer price index report showed that U.S. inflation slowed to 2.5%
• Polling markets suggest that the race for the White House remains extremely tight
• Exports surged in China while inflation stayed soft

On the latest edition of Market Week in Review, Director and Senior Investment Strategist Alex Cousley and Senior Internal Communications Analyst McKenna Painter discussed the August U.S. inflation report and its potential market implications. They also chatted about the upcoming U.S. presidential election and unpacked the latest trade and inflation numbers from China.

U.S. inflation continues to ease  

Painter and Cousley began with a look at the U.S. consumer price index (CPI) report for August, which showed headline inflation slowing to 2.5% on an annual basis. This was the lowest inflation reading in over three years and represented a further easing from July’s reading of 2.9%, Cousley said.

However, he noted that core inflation—which excludes the volatile food and energy sectors—came in slightly higher than consensus expectations, increasing 0.3% from July to August. Regardless, Cousley said he doesn’t expect the core inflation numbers to impact the U.S. Federal Reserve’s (Fed) upcoming decision on interest rates.

“Recently, Fed officials have shifted their focus from inflation to employment. With the labor market having cooled notably in the past few months, we think the Fed will cut rates by 25 basis points (bps) on Sept. 18 and continue to deliver 25-bps cuts at each subsequent meeting until the policy rate is between 3.0% to 3.25%,” Cousley stated. He explained that he believes the neutral rate—the rate at which monetary policy is neither speeding up nor slowing down the economy—is probably within this range.

The onset of the Fed rate-cutting cycle will impact the outlook for U.S. government bonds, Cousley said, noting that the Russell Investments strategist team had viewed them as an attractive tactical opportunity up until recently. “Earlier this year, we saw compelling tactical opportunities in government bonds due to attractive valuations and oversold sentiment, but valuations today are closer to fair value rather than cheap, and sentiment is no longer oversold. All in all, I think the tactical opportunity in U.S. government bonds has largely played out,” he stated.

What are markets focusing on as the U.S. elections near?

Turning to U.S. politics, Cousley noted that the latest polling data suggests that the race for the White House remains extremely close, with Vice President Kamala Harris and former President Donald Trump neck-and-neck in several key battleground states. He said that from a market standpoint, the biggest watchpoint right now is whether there will be any kind of a Democrat or Republican wave that could lead to either party controlling all three branches of the U.S. government.

Cousley explained that large swings in policy tend to occur most often when the House of Representatives, the Senate, and the presidency are all controlled by the same party. At this point, though, polling markets believe a divided U.S. government is more likely, he said, adding that investors will be paying close attention to policy proposals from both parties in the weeks ahead.

China’s exports increase while domestic demand remains weak

Painter and Cousley wrapped up the segment by assessing the latest economic numbers from China, including trade and inflation data. Cousley said that the trade numbers for China were better than expected, with exports growing 8.7% in August on a year-over-year basis. However, he cautioned that this pace of growth may not be sustainable moving forward.

“Given our view that the global economy is slowing, I’m not sure we’ll see this trend continue. On the other hand, it’s possible that Chinese exports could increase pending the outcome of the U.S. presidential election,” Cousley said. He explained that Trump has made tariffs a big focus of his re-election campaign, and that if the former president were to win, manufacturers might expedite the shipping of their products in order to get ahead of any potential tariffs.

Meanwhile, the latest data from China’s National Bureau of Statistics showed that inflation remains soft, Cousley said, noting that consumer prices were up only 0.2% in August on an annual basis. “China is very close to deflation,” he remarked, adding that the world’s second-largest economy has been beset by weak consumer spending the past few years. This stands in stark contrast to many Western countries, which instead have spent the better part of the last two years grappling with too-high inflation, Cousley noted.

He said he thinks the Chinese government will likely respond with more stimulus at some point to shore up domestic demand—but that the country’s economy may need to soften further before that happens. “I believe China’s leaders will probably need to see even weaker economic data before announcing further stimulus measures,” Cousley concluded.

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