Wednesday’s release of the consumer-price index reportfor July contained enough downside surprises to give stock investors hope the worst of inflation may be behind. Yet an undercurrent of worry remained at big-name firms like PIMCO, where the focus was on stickier components of the data that may only get worse.
According to PIMCO economists Tiffany Wilding and Allison Boxer, the details of the report were “firmer” than what was implied by the annual headline CPI rate — which fell to 8.5% for July from 9.1% in June and came in below the expectations of economists and inflation-derivatives traders. If food and energy prices continue to ease, June will likely prove to be the peak in year-over-year headline inflation, Wilding and Boxer wrote in a note. But the annual core measure, which strips out food and energy, “will likely reaccelerate in August, and isn’t likely to peak until September.”
The so-called core reading, which excludes volatile items, matters to many in financial markets because it’s supposed to represent a true underlying read on inflation — though there’s some debate over which time frame of the core gauge is most relevant. The core gauge came in unchanged at 5.9% for the 12 months that ended in July, and at 0.3% on a month-over-month basis, down from 0.7% in June.
Wilding and Boxer point out that the categories which drove July’s weakness in core — airfares and hotels — “tend to be more volatile, whereas the stickier components (rents/Owners-Equivalent-Rent) remained firm.” In addition, the economists said, other core measures of inflation from the Cleveland Fed, New York Fed and Atlanta Fed “have all accelerated” — with the depth and breadth of inflationary pressures across items spreading out. Meanwhile, wage inflation has also broadened from low-wage, low-skills services positions into a range of industries, jobs, and skill levels, they said.
“Today’s print didn’t change our forecast for core inflation of 5.5% and 3.5% year-over-year, for 2022 and 2023, respectively, nor did it change our near-term outlook for the Fed,” the PIMCO economists said. They still see a relatively high chance of another 75 basis points in September.
Bond giant PIMCO, which managed $1.82 trillion as of June, isn’t alone in sharing its hesitancy about July’s CPI data, even while economists at BofA Securities and Jefferies called a peak in inflation. Robert Frick, corporate economist with Navy Federal Credit Union, said “we’ll need a few more of these to call a peak and to see a meaningful downward trend.” Meanwhile, Comerica Bank’s Bill Adams said the U.S. is at risk of “another energy price shock” over the winter in the likely event that Europe suffers an energy shortage.
Investors “have been more than anxious to call a peak in prices,” and “the softer July headline is likely to perpetuate the notion that the worst of the cost pressures are now in the past,” said Lindsey Piegza and Lauren Henderson of Stifel Nicolaus & Co. But “the market has been violently (over) reacting to a single data point for some time now” and Fed policy makers need several months of significant price declines before becoming convinced that inflation is moving sustainably lower.
After Wednesday’s CPI release, fed funds futures traders dropped their expectations for a 75 basis point rate increase by the Fed in September, to 37.5%, while boosting the likelihood of a smaller 50 basis point hike to 62.5%, according to the CME FedWatch Tool.
All three major U.S. indexes
were higher into afternoon trading, with Dow industrials up by almost 500 points. Meanwhile, investors dove into bonds and sent most yields lower, led by declines in the 2-year
and 3-year rates
which reflect the expected policy path for the Fed in the next few years. The benchmark 10-year yield
fell to 2.76%.
“The step down in core inflation is good news, but remember: We’ve been here before,” said Omair Sharif, founder and president of Inflation Insights.
Following a burst of inflation in the second quarter of 2021, core inflation moderated sharply in the third quarter and then accelerated again in the fourth quarter, he wrote in a note. What’s more, a similar situation played out between January and June of this year, he said. “We’ve had headfakes before, so this is no time for complacency,” Sharif said in a note.