Markets on edge ahead of high-stakes CPI release

Inflation gets its next big test Tuesday, and the results could ripple through everything from bond yields to rate-cut bets. July’s Consumer Price Index will show whether price pressures are easing — or whether tariffs, sticky shelter costs, and a cooling labor market are conspiring to keep them alive.

The consensus forecast points to a modest pickup: headline CPI up 0.2% from June, pushing the annual rate to 2.8%, and core CPI — which strips out food and energy — rising 0.3% on the month and 3% on the year. That’s a touch hotter than June’s pace, and a reminder that tariff-driven cost pressures are still working their way through the economy. Shelter costs remain the single biggest driver of core inflation, but they’re no longer the only one: Tariffs on a wide range of imported goods, from furniture and apparel to auto parts, are beginning to show up in the data.

The tariff factor looms especially large because it arrives just as disinflation was starting to feel durable. The White House’s ever-changing trade policies on imported goods have put pressure on categories that had been either flat or declining. New York Fed President John Williams warned in mid-July that tariffs could push inflation into the 3%–3.5% range, complicating the Fed’s path toward its 2% target.

Some analysts see a slightly warmer outlook than the consensus. J.P. Morgan is forecasting a 0.34% monthly gain in core CPI and about 3.1% year-over-year, writing that recent trade policy announcements have altered how companies think about pricing. “Tariffs and trade announcements last month may have led some firms to reassess the likelihood that tariff rates would come back down, thereby leading them to consider passing on more of the increase in costs,” the bank wrote in a note to clients. 

Gregory Daco, chief economist at EY-Parthenon, said in a recent newsletter that the tariff squeeze is no longer just a line item in corporate planning — it’s starting to feed through to the inflation data. In a recent note, he wrote that companies’ “logistics maneuvers and proactive pricing strategies may have bought us time, but that cushion is eroding.” By his estimate, tariffs accounted for roughly a quarter to a third of June’s CPI increase. With import prices holding steady instead of easing, Daco argued, foreign exporters are passing on costs rather than absorbing them. On the domestic side, U.S. firms are already reporting the fallout: earnings pressure, scaled-back investment plans, and slower hiring. Meanwhile, Goldman Sachs has quantified the tariff effect at roughly 0.12 percentage point for the month and expects it to persist into year-end.

That fine margin matters for traders already making sector bets ahead of the release. In a Monday note, Morgan Stanley chief U.S. equity strategist and chief investment officer Michael Wilson said he has tilted his equity strategy toward small-caps, industrials, and financials on the assumption that inflation will stay contained enough to keep a September rate cut in play. A surprise to the upside, he warned, could quickly hand the advantage back to the megacap growth names that have dominated the market all year.

U.S. stocks slipped Monday as investors positioned cautiously ahead of the CPI release. The S&P 500 fell 0.3%, the Dow dropped about 200 points (or 0.5%), and the Nasdaq Composite lost 0.3%, easing from record territory. Futures were mixed after the close, with S&P 500 and Dow contracts inching higher while Nasdaq-100 futures edged lower. The 10-year Treasury yield dipped to around 4.27%, while the dollar stabilized after last week’s slide. With volatility muted and major indexes still hovering near highs, markets largely treaded water, keeping risk in check until the inflation data hits.

The interplay between tariffs and inflation is colliding with signs of a cooling labor market. Payrolls grew by just 73,000 in July, unemployment ticked up, and job openings have been sliding for months. Those policy crosswinds have analysts split on what Tuesday’s data might mean for the Fed’s next move. ING strategist Francesco Pesole argues that a 0.3% core print “would give the Fed room to lower interest rates” in light of the labor market’s recent softening. Bank of America is less willing to declare mission accomplished. “In a stagflationary environment, it is dangerous to cut without clear evidence that inflation has peaked,” its economists wrote, adding that the risks of loosening policy too early remain “significant.”

Market reaction will hinge on the details inside the report. A broad-based increase — where categories beyond shelter and energy post gains — would challenge the idea that inflation is on a stable path back to 2%. A more concentrated rise, driven by volatile or policy-driven components such as tariffs, might give investors leeway to look past it. That distinction matters for bonds, where yields have been capped by expectations of slower growth, and for stocks, where leadership has already begun shifting toward rate-sensitive sectors like small caps and financials.

There’s also a political dimension to this month’s release. President Donald Trump’s abrupt — and unprecedented — firing of the Bureau of Labor Statistics commissioner on August 1 in the middle of a politically charged inflation fight has drawn scrutiny from investors who rely on CPI as the benchmark for the $2.1 trillion market for Treasury Inflation-Protected Securities. Thierry Wizman, a global rates strategist at Macquarie, flagged an unusual wrinkle: Growing political scrutiny of the BLS could make markets second-guess the credibility of the CPI data itself. He warned that if trust in CPI erodes, demand for TIPS could fade, weakening one of the market’s most important inflation hedges.

For traders, the setup is simple but fraught. A hotter-than-expected CPI could push Treasury yields and the dollar sharply higher, force markets to trim or abandon September cut bets, and hit stocks that have been buoyed by the prospect of easier policy. A softer print would cement expectations for a September cut and might even revive speculation of a larger move — though some on Wall Street worry that weak inflation, combined with soft growth, could signal a more troubling slowdown. 

For now, the market is betting on a cooler CPI reading. Futures pricing via CME’s FedWatch Tool puts the odds of a quarter-point cut next month at about 90%, but traders have been burned before by sticky inflation surprises. An upside miss earlier this year sent yields spiking and erased weeks of rate-cut optimism in hours. With tariff effects still rippling through supply chains and shelter costs proving stubborn, few are willing to call this print a done deal.

Only after the dust from the data settles will the Fed become the story. Policymakers meet September 16-17, and while the market is still pricing in roughly a 90% chance of a September rate cut, tomorrow’s CPI will shape how much conviction remains in that bet. Fed Chair Jerome Powell has repeatedly emphasized the Fed’s commitment to a data-dependent, wait-and-see approach. He recently said the committee is still “well positioned to wait to learn more about the likely course of the economy before considering any adjustments to our policy stance,” and warned that “if we cut rates too soon, maybe we didn’t finish the job with inflation. History is dotted with examples of that.” The July jobs report has given doves more ammunition, but Powell and most of the FOMC have so far resisted moving early, preferring to see whether tariff-driven price increases prove transitory or more persistent.

For now, investors are split between two possibilities: an inflation print that confirms the economy is gliding toward a soft landing — or one that signals sticky price pressures just as growth starts to falter. By mid-morning Tuesday, they could know which path they’re on, and so could the Fed.