Inside Markets — Risk Scenario

Calls for a September rate cut intensified after July non-farm payrolls came in weaker than expected and July CPI came in better-than-feared. This leaves markets priced for a 25bp September rate cut ahead of the August Jobs report due 9/5 and August CPI on 9/11. Justification for a September rate cut would have to come from the downside risk in labor markets rather than underlying inflation that remains ~100bp above the Fed’s 2% target. While tariff-related price increases are generally considered one-time in nature, it was services inflation driving last week’s upside PPI print that tends to lead CPI by a month. The July Jobs Report that raised concerns about downside risks also included faster wage growth, which doesn’t align with a 2% inflation outcome. It remains unclear that the Fed should be cutting given inflation, which makes the August CPI report (9/11) the most important near-term catalyst for equity markets.

A stronger-than-expected August non-farm payroll number and firmer August CPI print that keeps the Fed on the sidelines would likely result in bearish curve flatting and a potential spike in rate volatility. A big enough spike in bond market volatility could then spill into equity markets (VIX>22) causing a ~5% pullback in the SPX. The fallout could be even larger given that it would be occurring during a seasonally weak September-early October period.