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Thursday’s consumer-price report for July is boosting the likelihood that the Federal Reserve will take no action next month, while reinforcing the view in some corners of the financial market that U.S. inflation can keep coming down without a recession or major uptick in unemployment.
Still, there’s plenty of reason for investors to be careful about interpreting the report, which showed underlying core inflation easing over the past 12 months to 4.7% from 4.8% previously. Though stock investors initially cheered the data because it appeared to point to continued disinflation, they pulled back in afternoon trading. Fed funds futures traders now see a 90.5% chance that policy makers will leave rates between 5.25%-5.5% next month.
Macro strategist Will Compernolle of FHN Financial lists three reasons why his firm is cautious about reading the July CPI as “the end of worrisome inflation.”
- The 4.7% year-on-year core CPI rate, which strips out food and energy prices to provide a purer read on inflation, is still more than twice the Fed’s 2% target.
- Rising energy prices that began in late July should push up the headline inflation rate starting with data released next month, and “pose an upside inflation risk to the core index from pass-through to energy-intensive industries like manufacturing and transportation services.”
- The annual rate of core inflation based on another reading, known as the personal-consumption expenditures price index, is also far above the Fed’s 2% based on the most recent reading released in late July. The Fed targets PCE, and not CPI, inflation. And methodological differences between the two “have proven to be important this year, especially for components like airfares and medical care services.”
The bottom line is that the July CPI “was a very encouraging inflation report,” which boosted hopes for a soft landing and reinforced market expectations that the Fed has reached its “terminal rate,” Compernolle said in a note Thursday. “There are some upside inflation risks in the months ahead, but supply chain normalization is finally passing through to core goods disinflation and many of the other pandemic inflation villains are showing signs of better balance.”
See: Why ‘stunning’ jump in jet fuel, diesel prices may complicate Fed’s inflation fight in months ahead
On a monthly basis, the core CPI rate was 0.2% for a second straight month — the “best back-to-back monthly inflation readings since early 2021,” according to the macro strategist. Prior to Thursday’s data, “downticks in monthly core inflation were followed soon thereafter by reacceleration.”
Dow industrials
DJIA
pulled back from much of the 455-point jump seen earlier in the day, and the S&P 500 and the Nasdaq Composite were down as of Thursday afternoon. Meanwhile, Treasury yields were up following a soft 30-year auction and the ICE U.S. Dollar Index
DXY
turned 0.1% higher.
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