By: Kathryn Rooney Vera, Managing Director and Chief Market Strategist
From the desk of our senior advisor, Jon Hilsenrath.
Summary: The Bureau of Labor Statistics reported a modest rise in its consumer price index in July, up 0.2% from June and up 2.7% from a year earlier, just shy of StoneX forecasts (+0.26% m/m, +2.8% y/y)). The increase was likely small enough to encourage Federal Reserve officials to reduce the target federal funds rate by a quarter percentage point to below 4.25% when they meet again in September.
Though inflation has run above the Fed’s 2% target for 53 straight months, officials will likely view consumer prices as stable enough to justify a reduction in interest rates, given recent signs of a weakening labor market. We have been saying a September cut was a close call and expressed concern about upside risks to inflation. Given the latest data, a rate cut looks likely, barring a surprise rebound in employment data for August or a surge in inflation readings before the Fed meets Sept. 17.
Skepticsm on an October Move: Having said that it is far from obvious that the Fed will quickly follow a September cut with another cut in October. Futures markets place a 66% probability on another cut in the fed funds rate in October to under 4%. That looks ambitious. If the Fed moves again, it likely will be in December and it will likely be twice this year, not three times.
Deeper Dive, Core of the Matter: Looking deeper at Tuesday’s consumer price data, there is reason to believe inflation will remain above the Fed’s 2% target for some time. The less-volatile core inflation index – excluding food and energy – rose 0.3% in July and was 3.1% higher than a year earlier (in line with StoneX forecasts of +0.31% m/m, + 3.03% y/y). Core inflation moved briefly to under 3% in the March through June period but resumed a modest uptrend. In June Fed officials projected core inflation would finish the year at 3.1%. Today we learned it is already near that mark, with tariff effects still seeping into national price data. In June Fed officials projected core inflation would finish the year at 3.1% … today we learned it is already near that mark, with tariff effects still seeping into national price data.
Rent Relief: The most important source of downward pressure is rent, which in July retreated to a 3.5% increase from a year earlier, the lowest rate since 2021. Inflation gain as much weight in the Fed’s favored personal consumption expenditure (PCE) price index, meaning downward inflation pressure in the Fed favors is more modest than in the CPI, a reversal of what happened during a rent surge in 2022 and 2023, when CPI outpaced PCE.
Services Pressure: Excluding rent, services prices were 4% higher in July than a year earlier, up from 3.3% in April. Medical care is causing some upward pressure – it rose 3.5% in July from a year earlier, after holding below 3% during the first six months of the year. The BLS’s next release of producer price index data Thursday warrants close watching, since PPI measures of hospital care feed directly into the Fed’s favored PCE price index, as does the PPI measure of airfares, which rose 4% in July based on the CPI measure.
The Tariff Story: On the goods side of the ledger, tariffs show signs of creating inflation pressure as expected – commodities less food and energy were up 1.2% in July from a year earlier, the largest increase in a couple of years. Import-heavy sectors showed scattered upward pressure, including furniture (up 0.9% for the month and 3.2% for the year); tools (up 1.6% for the month and 2.6% for the year); footwear (1.4% and 0.9%); car parts (0.9% and 2.9%); and window and floor coverings (1.2% and 7.2). Deflation in the consumer tech sector also shows signs of slowing. In the decade before the U.S. trade war with China started in 2018, consumer computer prices on average dropped 9% a year; in July they were down 2% from last year.
Globalization and an era of low tariffs created persistent downward pressure in goods prices during the 2000s and 2010s; since the U.S. adopted a pro-tariff strategy in 2018 core goods prices have tended to rise, and as the Covid episode showed, they’ve been vulnerable to supply shocks. This suggests that more of the work of holding inflation down must be done on the services side of the economy than before. Inflation has now held above the Fed’s 2% target for 53 straight months. The central bank doesn’t have the scope to ease aggressively as growth and hiring slow, unless it is prepared to lose credibility on returning to its 2% inflation goal. September ease is likely given the weak job market and another move in December remains in the cards. The futures market places a greater than 50% chance of three rate cut this year. That still looks improbable. The CPI report fell within the green zone of the CPI decision matrix that we circulated Monday, supporting our view that it moves the Fed toward a September ease.
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