The annual rate of inflation as measured by the headline Consumer Price Index (CPI) dipped in July to 8.5%. That was down from June’s annual rate of 9.1%. Economists had expected the inflation rate to drop to 8.7%
However, the news wasn’t as positive on the core inflation front. This measure, which strips out more volatile energy and food prices rose at a 5.9% annual rate in July. That’s unchanged from the June rate.
The divergence in the headline and core inflation numbers is all about gasoline. The gasoline subindex fell 7.7% in July from June. That still left the energy subindex up 32.9% over the last year. But that is much lower than the 41.6% rate for June.
There are some big problems for the Federal Reserve in this data–and for investors trying to figure out what the U.S central bank will do at its September 22 meeting. Everyone in the financial markets believes that the Fed will raise its benchmark interest rate in September, but will the increase be 50 basis points or 75?
The drop in headline inflation, since it is based on a drop in gasoline prices that is all too easily reversed is probably not sufficient, in my opinion, to get the Fed to back away from the big 75-basis-point increase that it has signaled recently.
The market disagrees with me, by the way. The CME FedWatch Tool is showing odds of a 75-basis-point increase dropping to 37.5% today in the aftermath of the CPI report. That’s down from 68% odds yesterday, August 9. Odds of a 50-basis-point increase rose to 62.5% today from just 32% yesterday.
The Fed doesn’t use the CPI as its inflation measure, preferring the Personal Consumption Expenditures (PCE) index, but to the degree the Fed pays attention to the CPI, the key measure the bank watches isn’t the headline rate but the core rate.
Another problem for the Fed is that shelter, which makes up about a third of the index, continued to rise at a very high rate. The increase from June was 0.5% and that put the annual rate in July at 5.7%. That’s the highest since 1991. And looking at the housing market, the Fed sees nothing that would indicate that this hard-to-move sector inflation rate is about to moderate.
Wages, in a separate report this morning, dropped at a 3% rate in July from a year earlier. Real average hourly earnings are now down in every month since April 2021. Which is positive news if you’re looking for signs that the labor market is weakening. (Wait, we’re rooting for lower wages and for jobs to get harder to find?) But the surprisingly large number of jobs created in July–528,000–and the slight dip in the unemployment rate–to 3.5% from 3.6%–is likely to keep the Fed from concluding that labor tightness has moderated.
The yield and price on the 10-year Treasury are basically unchanged as of 1 p.m. New York time today, at 2.76%. That is just 2 basis points lower than yesterday’s yield. The 2-year Treasury, which is more sensitive to changes in the short-term Fed Funds rate was at 3.15% today after closing with a yield of 3.26% yesterday.
