The July consumer price index report arrived broadly in line with forecasts on Wednesday, offering some relief but failing to resolve the debate over where inflation is headed.
The CPI rose 0.1% for the month, bringing the annual rate to 3.4%, while core readings came in at 0.2% monthly and 2.5% annually, according to the Bureau of Labor Statistics.
Both headline and core figures reinforced a narrative that inflation, while still elevated above the Federal Reserve’s 2% target, is becoming a less acute problem after two consecutive months of moderate readings.
Much of the recent moderation has been driven by easing in the CPI energy index, which is now down 7% from its historical peak recorded in May of this year.
However, crude oil prices have surged roughly 10% over the past week, posing significant upside risks for the August inflation reading if tensions in the Middle East do not ease.
On the shelter front, the index that accounts for approximately one-third of total CPI weighting has risen just 0.1% over the past two months, offering some encouragement for policymakers watching housing costs closely.
A closer look reveals that recent shelter improvements have been driven largely by sharp declines in the lodging away from home category, which has fallen steeply in three of the past four months.
Owners’ equivalent rent, which assigns a hypothetical rental value to owner-occupied properties, has held relatively steady during the same period, limiting the overall progress on shelter inflation.
Stripping out food and energy, core inflation is now running at roughly the same level it was before the U.S. and Israel attack on Iran in late February, suggesting geopolitical disruption remains the primary inflation driver.
Traders responded to the data by cutting the probability of a September rate hike, with the CME Group’s FedWatch tool showing just a 38% chance of a move at the Fed’s September 15-16 policy meeting, down 10 percentage points from Tuesday and well below the roughly 70% probability seen a month ago.
Dan North, senior economist at Allianz Trade North America, said: “This makes life for the Fed a little bit easier because now there’s less pressure for that hike that everybody was expecting. Inflation appears to be getting tamer.”
Stephen Juneau, U.S. economist at Bank of America, maintained the bank’s contrarian view, saying: “We are sticking with our base case of 75 basis points of hikes this year, starting in September. But the somewhat benign inflation data over the last two months have increased the risks that hikes will either be delayed or won’t materialize.”
Niladri ‘Neel’ Mukherjee, chief investment officer at TIAA Wealth Management, offered a measured assessment, stating: “The July CPI report was highly anticipated as a crucial datapoint ahead of the FOMC September decision. But its release is unlikely to meaningfully change the stance of many FOMC voters, given elements potentially feeding both the dovish and hawkish narratives.”
The combination of the soft CPI print and last Friday’s weaker-than-expected nonfarm payrolls report for July has added further uncertainty to the Federal Reserve’s near-term policy path.