Headline US CPI Inflation Eased in July, but is it Enough to Slow the Fed’s Tightening?

US CPI Moderation

The all-items Consumer Price Index eased to +8.5% year-over-year, coming in below expectations and significantly lower from June's red-hot 9.1% print. The core reading, which excluded food and energy prices proved stickier, as it steadied at 5.9%, but lower than expected.

Energy prices have come down recently, with USOil running its third straight losing month, helping towards today's lower print. The U.S. Bureau of Labor Statistics disclosed that the energy index, increased by 32.9% year-over-year, significantly less than the June 41.6% y/y rise. The food index however, jumped 10.9% over the last year, marking the largest 12-month increase since May 1979. ^[1]

Markets have been searching for a peak in inflation for a long time now and today's data reignite hopes for such an outcome. However, we have been in a similar situation before, when prices had moderated in April, before accelerating again.

Market Reaction

After the last blowout employment report, markets were pricing in another outsized 0.75% interest rate hike by the Fed in September, but today's data poured cold water in those aggressive expectations. At the time of writing, CME's Fed Watch Tool projects a smaller 50 basis points move as the most likely outcome, with around 60% probability. ^[2]

The inflation moderation and the dovish repricing of market hike bets, caused the US Dollar to react lower and Wall Street to move higher, with SPX500 gaining around 1.5% at the time of writing.

Fed Implications

Today's release is encouraging and shows that the Fed's resolve to bring down inflation via an aggressive and front-loaded tightening cycle may be actually achieving its intent. Officials have hiked rates four times this year, with the latest one in July, marking the second straight 75 basis points move.

Chair Powell had reiterated that inflation is the top priority, but had also tempered expectations around future hikes, saying that it "likely will become appropriate to slow the pace of increases". ^[3]

Given the lagging nature of the monetary policy, there are fears of recession, as the US economy has contracted for two straight quarters this year. Officials have dismissed such worries, given mostly the strong labor market, and last week's blockbuster employment report, backs this narrative. However, Mr Powell had admitted that the path to a soft landing has "clearly narrowed".

Policy makers have repeatedly stated that they need to see inflation come down in a sustained manner. Ms Mester (voter) had told the Washington Post earlier in the month, that officials want to see inflation "on a sustainable downward path towards our longer-run goal of 2 percent", adding that they have not seen that ^[4]. Over the weekend, Governor Bowmann said that she supports continued rate increases "until inflation is on a consistent path to significantly decline" ^[5].

So today's release may not be enough for a less-hawkish pivot, by the Fed, especially as long as the labor market is so strong. Furthermore, the upcoming policy meeting is more than a month away, during which we expect more inflation data and another jobs report, so officials will most likely not base their next move on today's data.