The July Core CPI came in at +0.17% MoM, a better than expected versus consensus of +0.19% MoM. This is now the 4th consecutive “soft” inflation report and solidifies the case for the Fed to start a rate cutting cycle starting in Sept.
- The details of this report were very good:
– Core CPI MoM +0.17% (YoY fell to +3.17% vs +3.27% last month)
– the two largest contributors to inflation
– Shelter ex-hotels +0.17% CTG
– Auto insurance +0.04% CTG
– Ex-these two, Core CPI would be -0.04% MoM - As is the pattern for much of the past year, two components account for the bulk of inflation. Both of these are arguably lagging indicators and will eventually become disinflationary.
– auto insurance premiums are indeed rising and catching up due to past rise in claims
– currently, auto insurance still incrementally accelerating MoM +1.19% vs +0.92% prior
– shelter is on a glide path to lower as YoY is +5.05% vs 5.16% last month
– but this is a known “smoothed” series so it takes time - Outside of these 2, there are not really any anomalous inflation items. Used cars was a drag at -2.3% MoM (big decline) and will be less contributory in August CPI. But there are other offsets
- The case for a cut in Sept is near certain but the market is likely focused on the odds of a 50bp cut (vs 25bp):
– these odds stand at 48.6%
– prior to this CPI report, the odds were 60.7% - Why did the probability of a 50bp cut drop?
– for markets, the perception is a 50bp cut warranted if:
– economic softness warranting Fed action
– sudden collapse in inflation - Neither of these is true. Personally, we think inflation is far softer than consensus believes, which is evident by the fact that median inflation YoY stands at +1.18% vs Core CPI at 3.17% YoY.
- So, the Fed is too tight as a Fed funds at 5.50% (upper) versus +1.18% median inflation is massively high real rates. Thus, we believe Fed funds should be closer to the Neutral rate of 3% or so. And bigger cuts are warranted.
- However, this is not the market’s stance nor is this the Fed’s stance. Incrementally, this inflation report is important as it solidifies the case for a Sept cut. And there are many “inflation hawks” who don’t even think the Fed needs to cut.
- Over the next few weeks will be some important (and favorable) macro reports:
– 8/22-8/24: Fed Jackson Hole Economic Symposium, Powell speaks
– 8/30: July PCE (Fed’s preferred measure of inflation)
– 9/6: Aug Jobs report - Overall, these should be supportive of stocks in the near term. There may be some profit taking today given the sharp move higher yesterday (on PPI).
- But we view this inflation report as supportive of equities.
- Also supportive is the VIX spot currently stands at 17.24, well below 20.
- And 10-yr yields are lower at 3.818% (-3.6bp) also supportive.
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