My Thoughts on the CPI

What You Missed

Headline CPI rose 0.1% in July, bringing the annual rate to 3.4% from 3.5% in June. Core CPI rose 0.2% on the month and to a pace of 2.5% YoY. These metrics, for the most part, matched forecasts. Gasoline fell 2.9% during the month while electricity was nearly flat, up just 0.1%. Shelter costs and food both rose 0.1%. Recreation, new vehicles, apparel, and other categories also rose.

The Outside Context

Since the last Fed decision, there have been a number of analysts who’ve turned more dovish due to the job market. Nonfarm payrolls fell by 23,000 unexpectedly and badly missed expectations. May and June were also revised down by around 103,000 jobs. Wage growth and labor force participation also fell.

My Thoughts on What the Fed Should Do

As ever, the Fed is once again in a precarious situation. As you may have read in my recent article on the Fed decision, I supported holding rates on the logic that a hike wouldn’t change oil prices. With no end to the Iran conflict in sight, that remains an issue, but my condition on hiking has come to pass. Inflation has begun to seep back into Core CPI. Even while the headline CPI number fell YoY, I don’t expect this trend to continue as the Iran conflict is getting worse rather than better.

But the added nuance now is the labor market weakening. Even while the unemployment rate has dropped, much of that is attributed to the labor force participation rate also dropping to its lowest rate in 5 years.

Overall, while some were made more dovish by this report, I’ve become more hawkish. I now believe a rate hike is going to be necessary come September. The Fed will have more information by then to make its decision, but I think it will be inevitable unless we see a solution in Iran. Inflation simply cannot stay elevated like this. If we get another month of Core CPI inflation, then it’s confirmed that it’s a trend and not a one-off. Moreover, it’ll also be confirmed that it’s not just energy that’s the issue.

The obvious pushback is the labor market weakening, but costs increase for corporations just like the increase for consumers. Lowering the rate at which those costs increase can provide long-term support for hiring, even though it may cause more short-term weakness.

Disclaimer:

This blog post is for educational and informational purposes only. It is not financial advice. I am not a licensed financial advisor, and nothing in this post should be interpreted as a recommendation to buy or sell any securities. Trading involves risk, and results are not guaranteed. Past performance is not indicative of future results. Always do your own research and consult with a licensed financial professional before making any investment decisions. None of my statements or points of view are reflective of the views of Deep Knowledge Investing.