The Latest Twist in The Inflation Tale

Inflation reaccelerated in July for the first time in 13 months.

But beneath the surface of the 3.2% headline number revealed in Thursday's Consumer Price Index (CPI) report are several signs the Federal Reserve's fight against inflation is headed in the right direction.

“The July CPI report offered more convincing evidence that inflation pressures are abating,” EY-Parthenon senior economist Lydia Boussour said on Thursday.

Fuel price increases helped force headline inflation back up in July. When looking at “core” inflation, the Fed's preferred inflation gauge that strips out the volatile food and energy categories, prices rose at their slowest pace since October 2021. Core prices increased 4.7% year over year in July, down from 4.8% in June and 5.9% in July 2022.

On a monthly basis, core CPI increased 0.2% for the second straight month, marking the first time since February 2021 that core CPI rose just 0.2% in consecutive months. Stocks rose following the report.

“The report was encouraging,” Bank of America US economist Stephen Juneau wrote in a note on Thursday. “Sequential growth in core inflation continues to trend lower, and we wouldn't be surprised to see another soft August print given declines in wholesale used car prices. While (month-over-month) inflation is still likely to be bumpy, we believe that the current disinflation is not a ‘head fake.'”

Another measure the Fed has watched as of late — core services prices excluding shelter costs — rose 0.2% month over month, notably lower than the 0.4% to 0.5% increase to start the year, per Boussour.

“Fed officials will likely look at the report as one more step down the disinflationary path,” Boussour said. “But with inflation still far from its 2% destination – the FOMC will likely maintain a hawkish bias and keep the door open to further rate hikes if the data justifies it.”

Easing core inflation comes as other recent economic data has shown signs of a cooling labor market. Recent data showed the US economy added 187,000 jobs in July, the fewest since December 2020. Meanwhile, data from the Department of Labor out Thursday showed weekly jobless claims for the first week of August hit their highest levels in a month.

The confluence of data has investors increasingly confident the Federal Reserve won't hike interest rates at its next meeting in September. Markets are currently pricing in a 90% chance that Federal Reserve maintains its benchmark interest rate in a range of 5.25%-5.50% in September, per the CME FedWatch Tool. Before the recent jobs report and Thursday's CPI release, markets had priced in an 82% chance of a Fed pause next month. In early July, markets had priced in just a 72% chance of that scenario.

“It remains the case that the Fed is likely done with rate hikes for this cycle,” Jefferies US economist Thomas Simons wrote in a note on Thursday. “The Fed has been consistent in signaling that there is more work to be done on getting inflation back down to target. However, rather than prescribing more rate hikes, they now seem to think that they need more time with policy in restrictive territory in order to drive inflation down to their target.”

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