The Bureau of Labor Statistics reported Wednesday that the consumer price index rose 3.4% in July from a year earlier, a slight deceleration from June's 3.5% pace, which had marked the highest reading in three years. The figure matched the consensus forecast from economists polled by Dow Jones Newswires and The Wall Street Journal. On a seasonally adjusted basis, monthly CPI increased 0.1% in July, also in line with expectations, after a 0.4% decline in June.
Core CPI, which excludes food and energy, advanced 0.2% month over month and 2.5% year over year, both in line with projections. The core annual figure eased from June's 2.6% increase. The data arrive on the heels of a disappointing jobs report last week, which had already led many market participants to expect the Federal Reserve to hold its policy rate steady at the upcoming September meeting.
According to the CME FedWatch tool, as of Wednesday morning, the probability of rates remaining unchanged at the September FOMC meeting stood at 55.9%, while the odds of a hike to a target range of 3.75% to 4% were 44.1%. The tool updates in real time, reflecting shifting market expectations.
“Inflation is still drifting in the right direction, which is a small relief given the uncertain geopolitical situation,” said Nic Puckrin, macro analyst and founder of Coin Bureau, in a note. “But it’s still well above the Fed’s 2% target, so don’t mistake this glimmer of hope for proof that inflation has been beaten.” Puckrin cautioned that if tensions in Iran remain elevated, oil prices could stay high, complicating the Fed's efforts to bring inflation under control without resorting to further rate increases.
“The problem is, last week showed that the labour market is cracking,” Puckrin added. “That puts the Fed in a difficult bind. It can’t cut to save the jobs market without pouring fuel on the inflation fire, and if it hikes to tame prices it risks pushing the jobs market over the edge.”
Chris Zaccarelli, chief investment officer at Northlight Asset Management, echoed that sentiment. “The big surprise with a report that had no surprises is that a situation where inflation isn’t reaccelerating, coupled with the most recent, weak jobs report gives the Fed more time to wait,” he said. “Typically, the market would be buoyed by the thought of rate cuts, but in a world where many are expecting rate hikes, anything that can delay – or squash the need for – rate hikes will be viewed positively.”
The Federal Open Market Committee has maintained its policy rate steady since its second meeting under Chair Kevin Warsh, but three dissenting members have pushed for an increase. That internal division is likely to make the September gathering particularly contentious. “We expect the debate at the September FOMC meeting to be lively as the economy experiences a tight labor market while the inflation picture is quite blurry,” said Jeffrey Roach, chief economist at LPL Financial. “Our baseline is the Fed holds rates steady, but an increasing number of voting members are hawkish and could convince the majority to implement a hike.”
Stephen Coltman, head of macro at 21shares, argued that the latest CPI data could bolster the dovish camp. “This mild inflation report is perhaps not quite enough to put to bed the argument over whether or not to hike in September, but at the margin it further strengthens the dovish case,” he said. He noted that softer U.S. data have already triggered a tentative rebound in the “debasement” trade, with a weaker dollar, a steeper yield curve, and rallies in gold and bitcoin. Advisors may want to prepare clients for a more volatile policy debate this fall, as the Fed navigates between stubborn inflation and a cooling labor market.
