Today’s CPI report appears to put another nail in the coffin for the prospects of further Fed rate hikes this year.
Both headline and core CPI measures showed a 0.2% month-on-month increase, painting a picture of price growth that looks to be returning comfortably to target. The unrounded figures were even more optimistic at 0.167% and 0.160% respectively, adding to last month’s evidence. Granted, the year-on-year figures made for more interesting reading, with headline inflation actually increasing from 3.0% to 3.2%. But a slight uptick was expected due to a rebound in energy prices, as was the modest fall in YoY core inflation to 4.7%. Ultimately, today’s release held little in the way of a surprise for markets. For the Fed though, it could be a different story.
While some Fed speakers, including Chair Powell, had been keen to dismiss the June data as just a single soft print, that argument holds little water after today’s release.
Instead, markets appear vindicated, having dismissed hawkish Fedspeak warning of inflationary persistence. Notably, the Fed’s preferred supercore measure for inflation showed underlying price growth of 1.7%, less than 2% for the second month in a row, looking on a 3-month annualised basis. With this in mind, it is difficult to see how the Fed can credibly continue to hold the line insisting on one final rate hike this year. Therefore, we continue to expect that the July rate hike was the last of this cycle, in line with current market expectations. Given the lack of drama in today’s release, FX markets have been relatively unmoved. Indeed, having fallen earlier in the session as traders positioned for the release, the DXY dollar index has barely budged on the news as today’s new data just served to confirm pre-release expectations.
The Fed’s preferred measure of supercore inflation continues to show price growth running below their 2% target
Digging into the data, shelter was the primary culprit of continued price pressures, similarly to last month.
However, this is a component that is subject to severe lags relative to real-time alternative data from real estate data providers. The BLS noted that over 90 percent of the 0.2% monthly increase was accounted for by shelter, where the index rose by 0.4% MoM. But given the downward trend in the more timely indicators, headline inflation should gradually continue to ease over the coming months as these developments see themselves reflected in the official statistics. Other items that saw prices increase included motor vehicle insurance (+2.0%), education (+0.3%), and recreation (+0.1%) also adding a marginal upward contribution to the headline figure.
Smaller drag from energy prices drives slight uptick to headline inflation
Elsewhere in the release, most of our component-level expectations materialised, with both used vehicles (-1.3%) and airfares (-8.1%)—two key sources of the downward pressures to core inflation—continuing to drop off.
Both of these items are down considerably compared to last year, with used vehicle prices down -5.6% and airfares down -18.6% from last July as their post-pandemic surge continues to reverse. Considering that the Manheim index points to a continued decline in the wholesale market for used vehicles, we expect that price competition among auto dealers should continue to result in lower prices for consumers in the coming months. For airfares, TSA checkpoint data suggests that flight demand is still headed on the path lower for now, but price cuts should become less aggressive as airfares have now fully returned to their pre-pandemic levels.
In terms of the contributions to headline inflation, which is influenced by a full year of price changes and base effects, not just the latest month of data, a smaller drag from the energy sector was a key factor underlying the slight uptick to the overall index.
Energy prices are still down from last year (-12.5%), but they have slightly rebounded in recent months. Gasoline prices were 0.2% higher in July. That being said, the monthly increase in energy prices was smaller in July than in June, with this month’s 0.1% print falling short of June’s 0.6% gain. The main surprise in the energy category was that natural gas prices rose by 2.0% for consumers, as front month Henry Hub futures fell throughout the month. As the July decline in the commodity market was more than reversed in the first two weeks of August, it is unlikely that consumers will see relief on that front next month. Nevertheless, the Federal Reserve won’t respond to a slight uptick in energy costs, especially since the overall developments in prices for domestic demand-driven items are essentially in line with the inflation target.
With another soft release in the bank, traders seem disinclined to change their view on the prospects for further Fed hiking, with markets seemingly already telling the Fed loud and clear that they are finished.
Indeed, traders were projecting just a three in ten chance of a further rate hike this year. Naturally, given the lack of surprise in the data, this pricing has barely moved, with markets still seeing some tail risk for a final Fed rate hike. In terms of the next meeting, the odds of a hike dipped slightly from yesterday to 10%, but this was a marginal move, as they have already halved since the start of the month. As we noted previously, Chair Powell’s basis for dismissing June data as “only one report” looks increasingly weak. It was notable therefore that the Fed’s Williams noted just this week that “we’ve got the policy where we need to be,” while cautioning that decision making will stay data dependent. Whether this marks a more concrete shift in stance for the FOMC remains to be seen. But on this data we are inclined to agree, as are FX markets, with the dollar largely unmoved on today’s news.
Jay Zhao-Murray, FX Market Analyst
Nick Rees, FX Market Analyst