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Inflation data could cause big moves in either direction. Gold is widely bullish, but the upside may be limited unless there are new major economic developments.

The US will release CPI inflation data for July at 20:30 on Wednesday evening Beijing time. After the disappointing non-farm payrolls report triggered a plunge in global stock markets last week, the market is on high alert for any signs of economic data. Investors continue to remain cautious, and geopolitical concerns continue to weigh on market sentiment.

Observers warn thatInflation data could cause big moves in either direction.Weaker-than-expected data could heighten concerns about the economy, while strong data could undermine bets on the Federal Reserve to cut interest rates. The Fed continues to tread a line between maintaining economic growth and trying to control prices, but there is growing consensus that the Fed will continue toA number of recent economic data suggest that rate cuts are already too late.

Market expectations: The downward trend will continue

Wall Street's consensus expectations show that after recording -0.1% last month, CPI is expected to rebound to 0.2% month-on-month in July and remain at 3% year-on-year; after excluding volatile energy and food prices, core CPI is expected to rise to 0.2% month-on-month from 0.1% in June, but is expected to fall to 3.2% year-on-year from 3.3% last month.Wells FargoEconomists say:

“The July CPI report will likely provide further evidence that inflation is calming but is still not back to the Fed’s target.”

Goldman SachsThe bank expects core CPI to record 0.16% month-on-month, lower than the market consensus of 0.2%. The bank expects core commodity prices to fall back to 0.11% month-on-month, but service industry inflation will rise by 0.23%, offsetting this decline, mainly driven by owner equivalent rent (OER). With hotel prices rising by 0.50%, Goldman Sachs expects OER to rise by 0.29%. Another driving factor is auto insurance, where Americans' renewal rates are so high that they have even made headlines. Goldman Sachs expects auto insurance prices to increase by 0.7%.

Will CPI provide more evidence for rate cuts?

Inflation trends are crucial to the Fed's willingness to cut interest rates, but monthly data can be volatile.Interactive BrokersJosé Torres, senior economist at Interactive Brokers, said that after good inflation performance in May and June, the CPI data for July is expected to be "mediocre." "Energy has become the driver of inflation. Gasoline prices have rebounded slightly, and we expect new and used car prices to also rebound, partly due to lower interest rates," he said. He also expects housing prices, transportation services and health care to rise in July.

For two years, the U.S. inflation report has been key to market expectations of the Fed’s interest rate policy. Before the Fed and the Bank of Japan held their July meetings, the market did not even expect three rate cuts by the end of the year. However, a large unwinding of yen carry trades and a global stock market crash led bond futures to price in as much as 100 basis points of Fed rate cuts by the end of 2024.

Although most inflation components have fallen since peaking in 2022, they are still above the Fed's 2% target, and "super core" inflation excluding housing inflation has stubbornly remained around 4.5%.Priscilla Thiagamoorthy, senior economist at BMO Capital Markets, wrote:

“Similarly strong inflation readings (or higher unemployment) may be needed in August to convince a majority of the FOMC that inflation is moving convincingly toward its 2.0% objective.”

“One of the main risks is the timing and magnitude of the Fed’s rate cuts,” said Luca Santos of ACY Securities. “If the Fed delays easing monetary policy, the U.S. economy could face the risk of a further slowdown, leading to a potential recession… Conversely, if the Fed cuts too much, it could reignite inflationary pressures or cause financial market instability. Balancing these risks is critical to maintaining economic stability.”

Lydia Boussour, senior economist at EY-Parthenon, said the July CPI report "will provide more evidence that the process of inflation retreating is continuing and remains on track."The report will "strengthen the case for a rate cut at the Fed's September meeting."

According to the CME FedWatch tool, the probability of a rate cut by the Federal Reserve in September is almost 100%. However, after the weak July jobs report and market turmoil early last week,Market opinion is divided over whether the Fed should cut interest rates by 25 basis points or a more aggressive 50 basis points.

How might the market react?

With liquidity low during the summer holidays, markets could overreact to any inflation surprises.An upside surprise in inflation could reduce the 100 basis point rate cut currently priced into bond futures by the end of the year. Conversely, a downside surprise in inflation data would solidify expectations for a 50 basis point rate cut in September and more aggressive cuts in the future.

The Bloomberg World Rate Probability Function, which makes implicit forecasts for the federal funds rate in early 2027, finds that expectations are high for a big rate cut from the Federal Reserve next year, with the overnight rate expected to fall by at least two percentage points to just over 3%.

Tim Waterer, chief market analyst at KCM Trade, said:Gold prices would benefit if U.S. inflation data softens as it would rekindle hopes of a big rate cut by the Federal Reserve in September.Gold is considered a hedge against geopolitical and economic uncertainty and tends to benefit from a low interest rate environment. "Heightened tensions in the Middle East are also creating some safe-haven demand," said Jim Wycoff, senior analyst at Kitco Metals.

Currently, the market is worried that Iran will retaliate against Israel and trigger a larger conflict in the Middle East. In addition, Ukraine has launched the largest counterattack against Russia since the outbreak of the conflict, even breaking into the Russian border, sweeping across parts of the western Kursk region, and exposing the weaknesses of Russia's border defenses in the region.

TD Securities said in a report:Any way you look at it, gold is now viewed as a hot trade, with Wall Street unanimously bullish.It is important to note that the agency also believes that despite the generally optimistic market sentiment, the positions of macro funds may have reached their upper limit.Unless a recession is imminent, it will be difficult to increase investment in gold further.This means that the upside potential of gold may have been fully priced in by the market.Future upside may be limited unless there are new major economic changes.

In terms of the stock market, the market is still reeling from the global stock market crash on "Black Monday" last week.CitigroupAccording to the data from the call option parity,Traders expect the S&P 500 to move 1.2% in either direction when the CPI data is released on Wednesday.Data compiled by Bloomberg show that the price of contracts for the SPDR S&P 500 ETF Trust to protect against a 10% drop in the next 30 days is around the highest level since October last year.That’s twice the price of a contract that protects against a 10% increase.This is the largest ETF that tracks the broad market index.

Bank of AmericaAnalyst Ohsung Kwon noted that investors worried about a CPI data-triggered stock sell-off could buy S&P 500 put options, which are "cheaper" than buying hedges on the Russell 2000 (RTY) or Nasdaq 100 (NDX).

In addition, at 20:30 on Thursday evening, the United States will also release the so-called "horror data" of retail sales, which may show a small increase. But investors should be vigilant.A weak reading could reignite concerns about a consumer slowdown and a potential recession.