Prepare for a potential ‘nasty shock’ on Wednesday, macro strategists warn

Investors could be in for a significant surprise if Wednesday’s Consumer Price Index (CPI) report comes in higher than expected, Gavekal Research warns.

Markets are currently banking on aggressive interest rate cuts by the Federal Reserve, but an increase in inflation could quickly overturn those expectations, which Gavekal calls a “nasty shock.”

They note that the futures market is currently pricing in a 100% certainty of a rate cut on September 18, with a 50% chance of a cut more substantial than 50 basis points.

In addition, a full 100 basis point reduction is expected by the end of 2024.

However, Gavekal warns that a rise in inflation could trigger a “violent adjustment in stance,” forcing investors to rethink the Fed’s trajectory.

According to Gavekal, the debate within their team reflects the uncertainty in the wider market. Some analysts believe that structural factors will push inflation above the Fed’s 2 percent target, while others argue that factors such as a contraction in the money supply and the easing of supply bottlenecks will reduce inflation.

“Yes, the July employment report showed that the labor market continues to cool. This means wage growth will continue to moderate, reinforcing the disinflation narrative. At the margin, the arguments for rate cuts are added. But a rise in inflation would undermine that case. in the short term,” Gavekal said.

The Fed’s willingness to cut rates depends on inflation’s cooperation. If inflation surprises higher, the Fed could delay tapering, causing a rebound in the US dollar, higher bond yields and pressure on US stocks, especially growth stocks.

Gavekal suggests that in the event of such an inflation scare, the safest assets might be US dollar cash, Treasury bills and inflation-protected Treasuries. As Gavekal notes, with so much riding on the upcoming CPI release, it might be prudent for investors to brace for potential volatility on Wednesday.

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