What Happened?

US inflation in July came in exactly as forecasters had expected. Core inflation rose 0.2% month-over-month (MoM) and 4.7% year-over-year (YoY). That compares to 0.2% and 4.8% last month. The details are slightly less encouraging than the headlines, yet it is expected that the Fed’s hiking cycle has reached its end. One can’t be 100% sure, however, as there is still another CPI report and another payrolls report between now and the next Fed meeting. Should that data be meaningfully above expectations, the Fed may feel obligated to raise again. 

Under the Surface

Core inflation is now annualizing at around a 3% rate over the past three months and a 2% rate over the past two months. That’s encouraging progress toward the Fed’s 2% target. It will take longer for the year-over-year figures (less important for market participants than month-over-month) to reach that level, but inflation is moving in the right direction.

All Eyes on Housing

Goods prices remain flat to slightly negative and services prices are slowly normalizing. Outside of housing, services inflation has annualized at 2.6% over the past three months. Progress, but not yet back to target. Housing remains the key issue—while that inflation has fallen from its peak, it remains at a level inconsistent with the Fed’s 2% target. That said, it will continue to take time for the fall in house prices last year to flow through into the CPI calculation. House prices are being moderated, which troughed in January and are almost back to the June 2022 peak, as they will affect housing inflation over the medium term and make it harder for the Fed to continue achieving disinflation toward their target in 2024.

Headline Inflation

Headline CPI has been more volatile, as it tends to be. Energy price declines have brought the year-over-year headline inflation to 3.2%. That is still up slightly versus June’s data due to base effects that rolled off this month. That base-effect pattern will persist through year-end as the 2H22 declines in energy prices from the figures will be continued to be removed, which should keep headline inflation fairly flat even as core inflation falls.

And Yet…

While the disinflationary trend is affirmed by July’s data, there is one wrinkle that could be taken as a slight negative going forward. Used cars and airfares both contributed meaningfully to the downward trajectory, and one can’t expect those moves to repeat in the coming months, removing a disinflationary benefit.

Moderating inflation, a cooling labor market, and a progressive slowdown in economic growth can be anticipated. With that as the backdrop, on can expect that the Fed has reached the end of their hikes, though any acceleration in inflation could cause them to continue. Their bias remains toward tightening rather than cutting in the near term.