Today’s announcement from the US that annual headline CPI came in at 2.9% for July, slightly lower than the consensus expectation for 3.0%, and down from 3.0% in June, has given plenty of food for thought as to the health of the US economy and also when the Fed might cut interest rates.
David Goebel, Investment Strategist at wealth management firm Evelyn Partners, comments:
“The inflation numbers were all in line with expectations, apart from the headline figure which was slightly cooler. At 2.9%, it’s the lowest reading since the spring of 2021, when inflation first took off.
“Looking under the hood of the headline numbers, we see a deflationary contribution from used cars and airfares. The important shelter component, which comprises circa one-third of the overall basket, ticked up to 0.4% on a monthly basis from 0.2% in June, but this is consistent with prior readings, and continues to fall on an annualised basis.
“Looking at house and condominium prices, which tend to lead the shelter component, there is plenty of room for shelter to fall in the coming months, dragging headline inflation down with it.
“The so-called ‘supercore’ inflation, which excludes food, energy and shelter elements, rose 0.2% on the month which is moderate but higher than the deflationary readings we saw on this measure in both May and June.
“The July US jobs report, which was published on 2 August, caused a big repricing in the likely path for US interest rates. Expectations for the Fed meeting on the 18 September quickly moved to a 50bps cut, before retreating again to settle on being essentially undecided between 25 and 50 bps move.
“Today’s developments did little to shift that dial – market movements were small following the release, with Treasury yields ticking up very marginally and the US dollar unchanged relative to sterling.
“There is little here to suggest that the Fed would go for a 50bps cut in September and we think the original expectation of a 25bps cut continues to be the most likely outcome. There is plenty of data to come before then though, including August updates on both the jobs market and inflation.”
Also commenting on today’s US inflation data, Janet Mui, head of market analysis at wealth manager RBC Brewin Dolphin said:
“US inflation in July was broadly in line with expectations, with US headline CPI at below 3%, the first time since March 2021. July’s data is not perfect though, as housing inflation was up +0.4% MoM and still above +5.0% YoY. Sceptics will also point to the pickup in super-core (services ex-shelter) inflation in July, after two months of decline. But it’s worth noting that goods deflation deepened in July (driven by cars), which could be a symptom of weaker consumer demand.
Overall, the continual slowdown in headline and core CPI on a yearly basis supports the notion that the worst might be over, and that the focus for the Fed is shifting to employment.
The mix of both slowing activity and inflation data suggests a rate cut in September is highly likely, and it is fully priced in. A 25-basis point cut seems more likely than a 50-basis point cut, as activity is not weak enough nor disinflation satisfactory enough. Though it’s worth pointing out there will be one more CPI report ahead of the September meeting.”
Tiffany Wilding, Managing Director and Economist at PIMCO said:
“This report, marks the third print in a row where inflation has come in line with the Fed’s long-term inflation target – a return to progress after surprisingly firm inflation readings in the first several months of the year. Importantly, shelter inflation continued at the more moderate pace witnessed last month, as immigration flows that had been supporting this category continue to moderate after the Biden Administration’s recent actions at the southern border. Elsewhere, evidence of Amazon’s Prime Day discounts was visible across retail categories, while cars prices continued to contract as higher interest rates and tighter credit conditions weigh on consumer durables demand.
“This print should further increase Federal Reserve officials’ confidence that inflation is sustainably returning to their 2% long term mandate. The moderating shelter inflation, along with cooling labor markets, has brought inflation risks into balance and heightened focus on the real economy and employment risks. Along those lines, the raise of the unemployment rate has raised concerns that the U.S. economy may be weakening under the strain of high interest rates. Still, a more detailed look at the drivers of the unemployment rate raise show that stronger labor supply amid the influx of immigration has contributed, instead of the usual pattern of a loss of employment. The balance of evidence suggest to us, that the U.S. economy is returning to more normal conditions, after the unique set of factors that have driven performance since the pandemic. Real GDP growth is slowing after the solid 3% growth performance last year, but it isn’t crashing.
“Overall, we think conditions are right for the Fed to begin to move the funds rate back toward a more neutral stance of monetary policy. We expect a series of cuts starting in September, and a return to more neutral levels in 2025. Of course, if the economy weakens more than expected, we have no doubt that the Fed will take swifter actions.”
According to Nicolas Sopel, Head of Macro Research at Quintet Private Bank (parent of Brown Shipley), recession risks are overblown as he comments:
“Inflation worries have cooled significantly over the past few weeks, driven by easing inflation figures over the past months after it had surprised to the upside during the first part of the year. July data was no different with no upside surprises, as both consumer and producer prices came as expected or even lower than what was expected.
“More notably, headline inflation printed below 3% at 2.9%, the lowest reading since March 2021, confirming expectations that the US Federal Reserve will very likely start cutting interest rates in September. Expectations for interest rate cuts have been quite rife in recent weeks with markets increasingly pricing in more rate cuts when the stock market corrected a few weeks ago.
“We think a 25 basis points cut into the Fed funds rate is more likely than a 50 bps one in September. The US economy is still growing on the back of solid domestic demand. The recent weakness in the US labour data led investors to start questioning the longevity of the cycle itself and whether the Fed has held interest rates in restrictive territory for too long.
“However, we think recession risks are overblown. In addition, the inflation report showed that housing inflation, which has been sticky, contributed the most to the 0.2% increase in inflation in July compared to June. However, seasonal factors may have pushed some prices – such as hotels and holiday rentals – higher in July.”
