Inflation is Rosy for Rates

Fed Hikes Increasingly Unlikely

Last week’s weak Jobs report helped mortgage rates and this week’s inflation reports continued to help. The argument for the Federal Reserve (Fed) hiking rates is quickly evaporating. The Feds’ futures markets that predict its monetary policy decisions show a 69.2% probability of holding rates steady during the September 16^th FOMC meeting, a 57.0% chance of holding rates steady during the October 28^th meeting, and a 44.2% chance of a +25 bps rate hike during the December 9^th meeting (CME FedWatch Tool). 

“In-line inflation will keep the ‘no need to hike rates’ narrative that took hold after last week’s jobs report intact,” said Ellen Zentner of Morgan Stanley Wealth Management.

CPI Shows Core Inflation Easing

The Consumer Price Index (CPI) for July showed headline inflation rose 0.07%, which was rounded to 0.1%, in line with estimates. Yearly, it fell from 3.5% to 3.4%, as expected. This included a 2.9% drop in gas prices. The core rate that strips out volatile food and energy prices rose 0.2%, as expected. Yearly, core inflation slowed from 2.6% to 2.5%. The Fed’s target is 2% of core inflation. This yearly level matches the lowest reading since March 2021. 

Shelter Costs Still Have Room to Fall

As we have discussed, the shelter sector makes up nearly 45% of the core reading. There has been a long lag effect in this number as it takes time for the reading to catch up with real-time rental prices. The yearly shelter number is 3.2%. Compared to recent real-time rental reports from ApartmentList and others, there is still quite a bit of room for this shelter number to decline, which will push the core CPI even lower.

PPI Confirms Wholesale Inflation Cooling

On Thursday, we got the July Producer Price Index (PPI) which measures wholesale inflation. That is inflation felt by companies before the goods or services are sold to the end consumer. As we have discussed, this inflation doesn’t always get passed on to the consumer. July’s headline PPI was flat at 0%, which is better than the estimates of 0.2%. Yearly, headline PPI fell from 5.5% to 4.7%.  The core rate rose by 0.2%, better than estimates. Yearly, it fell from 4.7% to 4.2%. 

Weak Retail Sales Flag Slowing Demand

Retail sales fell 0.6% in July. This can be misleading as it incorporates gasoline prices. If gas prices go up and people spend more money, it shows as there are higher sales. The report also publishes a number excluding auto/gasoline. That figure fell 0.2%, much lower than estimates. This could be a turning point in consumer spending and indicate a much worsening economy. 

Looking Ahead: Light News Week

• Tuesday, August 18: ADP Weekly, Housing Starts and Permits, Pending Home Sales
• Wednesday, August 19: 20-year Auction, Fed Meeting Minutes
• Thursday, August 20: Jobless Claims