The CPI inflation rate is finally past its peak, we’re sure to find out Wednesday morning. Falling gas prices, retail discounting, the return of online deflation and a plunge in shipping costs all suggest there will be a pretty swift retreat from June’s 40-year-high 9.1% inflation rate.


The combination of a peak in inflation and a comedown from peak Federal Reserve hawkishness has been a bear market antidote. After sharp rallies since mid-June, the Dow Jones and S&P 500 have both climbed out of bear market territory. Only the Nasdaq’s loss still exceeds the 20% bear market threshold.

But Friday’s strong jobs report has reined in bullishness. Can a falling inflation rate give it a new jump-start?

CPI Inflation Rate Forecast

Wall Street economists expect the consumer price index to rise 0.2% in July, following June’s 1.3% surge. The annual inflation rate is seen easing to 8.7% from 9.1%.

However, core inflation, which excludes food and energy prices, isn’t expected to show much moderation. The core CPI is seen rising 0.5% on the month, after June’s 0.7% rise. The core inflation rate is expected to tick back up to 6.1% from 5.9%, with rising shelter costs a prime contributor.

Inflation Rate Expectations

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

The reason that matters to policymakers is that inflation sees into consumer psychology, affecting shopping behavior and even bargaining for wage hikes. The more inflation becomes entrenched, the harder it is for the Fed to uproot.

With signs that consumers are becoming less worried about prospects for permanently high inflation, the Fed will feel less need to expedite rate hikes.

No More Fed Forward Guidance

Already, Fed chair Jerome Powell said on July 27 that policymakers suspended forward guidance. They’ll go meeting by meeting, deciding the appropriate policy setting based on the latest data. What has changed? As the Fed’s key interest rate gets close to a neutral level and heads toward restrictive territory, policymakers will tend to move more gradually. That’s 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?

At the moment, Wall Street sees 67.5% odds of another 75-basis-point rate hike when the Fed next adjusts policy on Sept. 21. Those odds ballooned after Friday’s unexpectedly hot jobs report.

Here’s the good news: Odds of a bigger move may be overstated.

The decision to hike 75 basis points at each of the past two Fed meetings “was driven by rising inflation expectations, which have since moved down decisively,” wrote Jefferies chief financial economist Aneta Markowska.

Plus, we’re due for a second soft CPI report before the Fed meets in mid-September. At this point, Markowska sees potential for August prices to contract 0.2% vs. July amid a further fall in energy prices.

Fed’s Focus Shifts Back To Core Inflation

When oil prices were still surging, Powell seemed to downplay the Fed’s usual focus on core prices, saying the concept was unfamiliar to the households struggling with inflation.

Now that oil prices are falling, Powell is again focused on core inflation. “Core inflation is a better predictor of inflation going forward,” Powell said in his July 27 news conference.

“Core goods inflation should also subside in the coming months given the overwhelming evidence of easing supply chain pressures,” Markowska wrote. But she expects core services inflation to “remain sticky, supported by the tightness in housing and labor markets.”

Nonenergy services, or core services, accounts for 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 5.5% in June.

Recession Vibe Deepens For US Economy: IBD/TIPP

Two Economic Paths After Jobs Report

The initial Dow Jones reaction to the July jobs report was muted, partly because markets were looking ahead to soft CPI inflation data this week. However, in its wake, the hoped-for Fed pivot looks farther off. What’s clear from the report is that the labor market is as tight as a drum. If hiring really is as strong as the reported 528,000 job gain makes it appear, then the Fed has its work cut out for it.

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

The other possibility is that the jobs data is overstating labor market strength. 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 job market is weaker than it seems, there’s no reason to doubt the jobs report’s indication that the labor market is extremely tight. If that’s the case, then wage pressures and core inflation may fade more slowly. The Fed may stop tightening sooner, but a pivot to cutting rates and an end to balance sheet tightening may take a while.

Dow Jones Rally On Hold?

After Friday’s jobs report, financial markets are pricing in one more quarter-point rate hike to a range of 3.5%-3.75% by early next year. By mid-2023, financial market odds tilt toward easier policy. But a higher terminal federal funds rate makes the path to a soft landing all the more tricky. It suggests higher odds that the Fed will overshoot, causing a recession and an earnings letdown.

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

Having already staged a strong rally, it may take some soft core inflation readings to reignite the bulls.


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