Soft July CPI Raises Odds the Fed May Skip A September Rate Hike

The soft July CPI --only +0.1% m/m for Total and Core -- raises the odds that the Fed may hold back from hiking rates in September.  The Core now has risen just 0.1% for four straight months.  And, at least some of the slow pace cannot be attributed to one-off price changes.  Moreover, the chances are that the July Core PCE Deflator (due August 31) will print 0.1% or lower.  Its y/y would fall to 1.4% from 1.5% -- further away from the Fed's 2.0% target.  The August CPI is scheduled to be released several days before the September FOMC Meeting,  however, so today's report is not the final word ahead of the rate decision.

The most notable sign of low underlying inflation is the deceleration in Primary Rent to 0.2% m/m from its recent trend of 0.3%.  The slowdown suggests that the pace of rent increases is adjusting down to wage inflation -- as rent presumably cannot outstrip wage gains forever.  To be sure, the lower pace would need to persist in coming months to be credible.  This slowdown did not show up in Owners' Equivalent Rent, which rose 0.3%.  But, OER reflects a smaller sample and is constructed with an energy adjustment that could be lifting it now.  While OER has a much larger weight in the CPI than does Primary Rent (reflecting the large percentage of households owning homes), OER has a smaller weight in the PCE Deflator than in the CPI.   As a result, it will boost the Core PCE Deflator less than the Core CPI, suggesting the risk of 0.1% or lower in the Fed's more important Core PCE Deflator.

While Fed officials could point to some components with likely one-off drops, there are others that appear to be one-off jumps, as well.  Some of this reflects volatility, with sharp moves following similarly sharp moves but in the opposite direction in the prior month.  Some recent price declines could reflect the pass-through of lower oil prices, which has ended for now.  For example, airfares fell sharply in May and June, but edged up in July.  Airfares in the PCE Deflator, however, are based more on the PPI's measure than the CPI's.  And, airfares fell in the July PPI.  So, this is another reason why the Core PCE Deflator will print low.

In general, the mixture of increases and declines among components -- which in part could reflect relative price changes -- nets out to a conclusion that overall inflation remains low.