The CPI inflation rate is finally down; The good news and the bad news for the Dow Jones

The CPI inflation rate finally passed its peak, we are sure to know on Wednesday morning. Falling gasoline prices, retail rebates, the return of online deflation and falling shipping costs all suggest there will be a fairly rapid pullback from the inflation rate of 9, 1%, the highest for 40 years in June.


The combination of spike in inflation and a drop in the Federal Reserve’s spike in aggressiveness has been an antidote to the bear market. After strong rallies since mid-June, the Dow Jones and the S&P 500 have both exited bearish territory. Only the Nasdaq loss still exceeds the 20% bear market threshold.

But Friday’s strong jobs report dampened the uptrend. Can a drop in the inflation rate give it a fresh start?

CPI Inflation Rate Forecast

Wall Street economists expect the consumer price index to rise 0.2% in July, after rising 1.3% in June. The annual inflation rate should go from 9.1% to 8.7%.

However, core inflation, which excludes food and energy prices, is unlikely to show much moderation. Core CPI is expected to rise 0.5% for the month, after rising 0.7% in June. The core inflation rate is expected to pick up from 5.9% to 6.1%, with rising housing costs being one of the main contributors.

Inflation rate expectations

Yet not only headline inflation is falling, but so are inflation expectations. The New York Federal Reserve’s survey of consumer expectations released on Monday found that the median inflation expectation three years ahead fell to 3.2% from 3.6% the previous month. Five-year inflation expectations fell to 2.3% from 2.8%.

The reason that matters to policy makers is that inflation seeps into consumer psychology, affecting buying behavior and even the negotiation of salary increases. The more entrenched inflation becomes, the harder it is for the Fed to uproot itself.

With signs that consumers are less and less worried about the outlook for sustainably high inflation, the Fed will feel less need to accelerate rate hikes.

No more Fed futures guidance

Already, Fed Chairman Jerome Powell said on July 27 that policymakers had suspended forward guidance. They will go meeting by meeting, deciding the appropriate policy setting based on the latest data. What changed? As the Fed’s key rate moves closer to a neutral level and into restrictive territory, policymakers will tend to act more gradually. This is especially the case because signs of economic weakness have spread from housing to consumer spending to business fixed investment.

The next Fed rate hike: 50 or 75 basis points?

For now, Wall Street sees a 67.5% chance of another 75 basis point rate hike when the Fed adjusts policy on Sept. 21. Those odds skyrocketed after Friday’s surprisingly hot jobs report.

Here’s the good news: the odds of a bigger move might be overstated.

The decision to hike 75 basis points at each of the last two Fed meetings “has been driven by rising inflation expectations, which have since fallen decisively,” the chief economist wrote. Jefferies Finance, Aneta Markowska.

Additionally, we are expecting a second loose CPI report before the Fed meeting in mid-September. At this point, Markowska estimates August prices could contract 0.2% from July amid further declines in energy prices.

The Fed is focusing on core inflation

When oil prices were still rising, Powell appeared to play down the Fed’s usual focus on core prices, saying the concept was unfamiliar to households struggling with inflation.

Now that oil prices are falling, Powell is once again focusing on underlying inflation. “Underlying inflation is a better predictor of inflation going forward,” Powell said at his July 27 press conference.

“Underlying goods inflation is also likely to ease in the coming months given the overwhelming evidence of easing supply chain pressures,” Markowska wrote. But she expects inflation for basic services “to remain sticky, supported by tighter housing and labor markets.”

Non-energy services, or basic services, make up 57% of consumer budgets, according to the Labor Department, led by housing and medical care. The inflation rate in these categories hit a 30-year high of 5.5% in June.

Recession mood worsens for US economy: IBD/TIPP

Report on the two economic paths after employment

Dow Jones’ initial reaction to the July jobs report was mixed, in part because markets were pricing in weak CPI inflation data this week. However, in its wake, the Fed’s hoped-for pivot seems more distant. What is clear from the report is that the labor market is as tight as a drum. If hiring is really as strong as the reported gain of 528,000 jobs suggests, then the Fed has its work cut out for it.

Deutsche Bank economists say the jobs numbers “reinforce our consensus call above for a terminal federal funds rate of 4.1%, to which the market now appears to be waking up.”

The other possibility is that the employment data overestimates the strength of the labor market. The Labor Department’s household survey shows the number of people working has fallen by 168,000 over the past four months, even as the employer survey shows 1.68 million new jobs.

But even if the labor market is weaker than it looks, there is no reason to doubt the employment report’s indication that the labor market is extremely tight. If so, wage pressures and core inflation may fade more slowly. The Fed could stop tightening sooner, but a pivot to cut rates and end balance sheet tightening could take some time.

The Dow Jones rally suspended?

After Friday’s jobs report, financial markets are pricing in another quarter-point rate hike to a range of 3.5% to 3.75% by early next year. In mid-2023, financial market ratings are tilting towards a looser policy. But a higher terminal federal funds rate makes the path to a soft landing all the trickier. This suggests a higher probability of the Fed overshooting, causing a recession and lower earnings.

On Tuesday, the Dow Jones slid 0.2% and the S&P 500 0.4%. The Nasdaq, which had outperformed in recent weeks, fell 1.2%.

Having already staged a strong rally, it may take some underlying inflation readings to rekindle the bulls.


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