Good News on Inflation Comes With an Asterisk

The soft-landing narrative for the US economy assumes that a summertime string of comforting inflation data, both at the consumer and producer levels, opens the door even wider for the Federal Reserve to declare as early as next month the end to one of the most concentrated rate-raising cycles in decades. With that, the economy would avoid a recession, interest rates would fall in an orderly fashion, stocks would build on their already impressive gains, and highly levered corporate exposures would be normalized methodically.

Thursday’s headline-grabbing inflation data for July supports this reassuring storyline for the economy and markets. This is the case both at the overall level and at that of key individual components of the consumer price index, including core services. With that, traders have rushed to lower the implied probability of a Fed rate hike in September to below 10% and to increase the likelihood of rate cuts starting just a few months later.

There is certainly a lot to like in the latest CPI report. There is also a need, however, for greater care in simply extrapolating its path given some price developments in the pipeline.

Let’s start with the good news.

Consistent with the consensus forecasts, the CPI rose by 0.2% at both the headline and core levels in July. This took the annual measures of inflation to 3.2% and 4.7%, respectively. It supported the notion that the disinflationary process is well anchored, that further favorable news is coming down the road, and that this will enable the Fed both to refrain from increasing rates in September and to position itself for cuts early next year, if not before.