Traders prepare for Fed's most popular inflation report on Friday: Price pressures likely to rise further in July – Invesco QQQ Trust, Series 1 (NASDAQ:QQQ), iShares Russell 2000 ETF (ARCA:IWM)

The next Personal Consumption Expenditure (PCE) inflation report, which is closely watched by the Federal Reserve, will be released at 8:30 a.m. ET on Friday.

This highly anticipated inflation report will likely provide insight into whether overall price pressures are consistent with the Fed's 2% target or whether they remain more stubborn than expected.

During the Jackson Hole Economic Symposium in Wyoming last week, Fed Chairman Jerome Powell hinted at a possible interest rate cut and said “it is time to adjust policy.”

He expressed confidence that inflation is approaching the Fed's target. Market traders are factoring in a rate cut at the Federal Open Market Committee meeting on September 18. The probability of a 25 basis point cut is 63.5 percent, and of a 50 basis point cut is 36.5 percent, according to CME Group's FedWatch tool.

What economists expect from the July PCE report

• The consensus among Wall Street economists, tracked by TradingEconomics, expects the annual PCE inflation rate to rise to 2.6 percent in July from 2.5 percent in June, ending a three-month slide.
• On a monthly basis, observers expect PCE to rise by 0.2%, after 0.1% in June.
• Core PCE inflation, which excludes food and energy, is expected to rise to 2.7% annually from 2.6%, with a steady monthly increase of 0.2%.

PCE increase in July likely due to base effects

If these predictions are correct, PCE inflation would rise in July compared to June's figures. Bank of America analysts attribute this increase to base effects in the annual figures.

“We forecast July PCE inflation of 0.17% and core PCE inflation of 0.19% month-over-month. This would translate into annual rates of 2.6% (headline) and 2.7% (core), representing an increase of 0.1 percentage point due to base effects,” BofA analysts said.

This upward trend should not be interpreted as a sign of rising inflation. Analysts recommend focusing on the three- and six-month annualized rates to get a clearer picture of inflation trends.

Possible impact on the market

A higher than expected PCE report could boost the US dollar index (DXY), which is Invesco DB USD Index Bullish Fund ETF UUP. US Treasury yields could also rise, potentially leading to a decline in iShares 20+ Years Treasury Bond ETF TLT.

Unless the report reveals a significant increase in inflation, it is unlikely to dash expectations for a rate cut in September.

Conversely, a lower-than-expected PCE report could benefit equity markets. SPDR S&P 500 ETF Trust SPY and the Invesco QQQ Trust QQQ are expected to rise on Friday if data supports the likelihood of impending interest rate cuts.

Small caps, pursued by the iShares Russell 2000 ETF IWMcould also be a big market beneficiary of a mild PCE inflation report for July.

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Illustration created using artificial intelligence via DALL-E.